Bank of America is Wrong: We’ve All Become Preppers Now

Inverted bond yields a sign of things to come from things gone bye?

Bank of America says it is dangerous to ignore the stock market, but a longer tradition says the bond market is the wiser of the two, and it is dangerous to ignore the bond market.

Bank of America dreams corporate cash could roll into stocks.

The extreme attractiveness of stocks over bonds, particularly as rates have plummeted back to near zero, can be the catalyst for the rotation into stocks, driving the market higher…. As the economy enters what our economists forecast as the worst recession in the post war era, the market is telling us not to worry. And it is dangerous to ignore the market.

Right now, money has piled into bonds as a safe haven, and the bond market is supposed to be wiser:

“Stocks and bonds have always been thought of as great indicators of future economic activity. Urban myth — and maybe earlier, too — suggests that the bond market is smarter than the stock market and is sometimes a more stable, reliable metric,” said Bob Johnson, Morningstar’s director of economic analysis. “Or perhaps stocks lead the economy and bonds lead the stock market.”

Even Bank of America’s Savita Subramanian, who warned about not ignoring the stock market, says in the video above that policy-makers in both the government and the Fed have pulled out all the stops for stimulus, yet each new round of stimulus is seeing diminishing returns in the stock market:

The worry now is what else is going to keep the market propped up…? Every time you get some bout of stimulus, you see a lower risk rally than the prior bout…. We’re kind of maxed out in terms of stimulus…. We’re in a bit of a tough spot in terms of how to get higher from here.

Finding an alternative path out of that tough spot is why Bank of America is looking to accumulated corporate cash to make a swing into equities. They’re hoping cash is waiting to invest or waiting to do more stock buybacks. I think they are dreaming.

BofA wasn’t saying the market will make that swing but that it is one of the last areas where they see money couldcome from to save the day. They’re actually forecasting the market will go a little lower by year end.

Corporations are acting like preppers

I have an alternative explanation.

I’ll note that the last two times stocks were telling us the economy was going to go higher while bonds were telling us it was going to go lower in a big way, bonds won in a big way. That was before the stock market’s crash in the fall of 2018 and then shortly before the recent greater crash.

I think cash is being banked while it can be to replace revenue that will be lost in the months ahead during the ongoing the Coronacrisis. Corporations are prepping — prepping to become survivalists.

With the Federal Reserve (and US government) backstopping US corporate bonds now, corporate bonds are seeing super-cheap yields even as corporate credit is being downgraded.

The coronavirus pandemic has spurred U.S. companies with investment-grade credit ratings to borrow at the fastest pace in history to start a year, with new bond issuance topping $1 trillion in less than five months, supported by Federal Reserve programs to buy corporate bonds…. It’s about double the pace seen last year over the same period, per BofA data.

Getting low interest in these hard times is no different than getting a cheap bank loan as a student on hard times because it comes with a government guarantee to the bank.

Demand for bonds as safe havens during a crisis is so intense right now that it is also driving down interest on new corporate debt.

Companies are seizing the day while the offer is available. They’re not going to wait until they need the cash and then find out that it ran out like the Payroll Protection Program (PPP).

It is wiser to refinance your credit now while it can still be done cheaply, especially if you’re being downgraded.

You also know you’re not going to have enough revenue to pay the bills and will have to have a lot of credit in the months ahead to make it through.

Bank of America missed the tell

Here’s the tell as to what is motivating the cash piling:

As an example, AutoNation Inc. … a national chain of car dealerships, with credit ratings one step above speculative-grade (or junk-bond) territory … borrowed $500 million in the bond market Tuesday…. AutoNation was one of several public companies that gave back funding from the U.S. Treasury Department’s hallmark $670 billion Paycheck Protection Program…. The Treasury warned earlier in May that the program was not meant for “a public company with substantial market value and access to capital markets.”

Do you see what happened there? AutoNation sought a cash grant to survive during the Coronacrisis. It also found it was on questionable ground with the governnment. In addition, it likely feared the same backlash other companies faced when trying to scoop up those emergency coronacash funds.

Afraid they’d be hit by penalties and public ridicule, AutoNation “gave back” the free cash. Their funding needs did not go away, so just like Shake Shack in the article just referenced, they turned to other capital markets, as the government asked them to do.

Like many of its peers, AutoNation swung to a net loss of $232.3 million in the first-quarter, or $2.58 a share, from net income of $92.0 million, or $1.01 a share … as car sales plunged during nationwide shutdowns.

AutoNation is just salting away enough cash to keep the lights on while I think BofA may be looking for a rosy-eyed picture to present to equity investors.

What could go wrong? While a lot of attention has been paid to new borrowing activity, there also has been a blistering pace of credit-ratings firm downgrades hitting U.S. investment-grade companies, with BofA tracking more than $1 trillion since the end of February.

In fact, Wendy Wyatt, portfolio manager at DuPont Capital Management warned

that credit ratings painted too rosy a picture of U.S. corporations, particularly since many companies were “over leveraged going into the crisis,” and now face a revenue hit from weeks of lockdowns designed to tamp down the coronavirus…. “Now they have to borrow a year’s worth of cash to burn, to keep the company moving forward, but their ability to continue to pay that indebtedness has decreased.”

Bank of America should be dreaming less about the heady days of corporate stock buybacks and thinking about the troubles ahead. If companies are rising cash for buybacks, they’re fools because it will soon be spent, and stocks may crash anyway, leaving those companies with neither cash nor credit to carry them through the storm.

Hopefully, the motivation for their cash hoards is not the foolishness that BofA envisions, and they’re getting their hands on cash while it can still be had.

I think we’ve all become preppers now — even US corporate bosses.

(This article was written originally for CCN.)

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