Thursday, February 22, 2007

"Hall of Fame" A New Era / pimco

looks like the risktakers don´t need to invent the cash cow. they have found it .....for now.
once more fantastic stuff from pimco.

die cash cow muß momentan nicht erfunden werden. die scheint momentan überall vorhanden zu sein. wieder einmal mehr geniales von pimco

Global Liquidity Boom
The global financial system is indisputably experiencing a boom in liquidity, driven by growth in corporate cash balances, foreign central bank reserves, private equity and hedge funds. This liquidity boom, along with new financial products, is changing the way that investment professionals traditionally view, evaluate and invest in financial markets. On the corporate front, strong global economic growth and easy global monetary policy over the past several years have led to a sharp rebound in corporate profit growth. In the United States, corporate profits as a percent of nominal GDP are now at 40-year highs (Chart 1). Despite this solid profit growth, most CEOs have remained conservative with capital spending.

As a result, corporate cash flow and cash balances have soared, providing Corporate America with a surplus of funds.
The growth in cash on corporate balance sheets is serving as a catalyst for rising shareholder activism. Aggressive shareholders are increasingly putting pressure on management to redirect large cash balances toward share buybacks and increased dividends. High cash levels are further helping to facilitate more mergers and acquisitions. In addition, private equity investors are tapping into Corporate America’s significant cash position to use as part of an initial equity stake for leveraged buyouts (LBOs). These trends, influenced by high corporate cash balances, are fueling a global boom in equity markets. Thanks to easy access to capital from both the high yield and bank debt markets, cash is being transferred from bondholders to shareholders as Corporate America engages in a re-leveraging campaign.

International developments have also bolstered global liquidity. Solid global economic growth has boosted exports from emerging economies and supported rising commodity prices. The resulting trade surpluses have led to rapid foreign exchange reserve accumulation by central banks in emerging markets (Chart 2), ....., central banks have supported the U.S. bond market by helping to keep interest rates low, contributing to generous liquidity conditions.

The broader change in global savings patterns has been dramatic. Current account deficits in the emerging world have given way to current account surpluses. Borrowers have turned into lenders. China, now with a current account surplus of over 8% of GDP, exemplifies this trend of capital rolling “uphill” from the developing world to the developed world. In addition to Asian savings, the rise in crude oil over the past several years has resulted in massive savings by oil exporters, a large portion of which have flowed into sovereign investment funds in Middle Eastern countries. ...

foreigners have become the dominant bid in some segments of the U.S. market. In the U.S. corporate bond market, foreigners are increasingly shifting their bond allocations into credit markets, in order to earn higher yields. Due to large foreign capital flows, the credit market is currently in a state of technical imbalance in which the demand for bonds is greater than the new supply of bonds. Over the past three years, foreign buyers have absorbed more than 100% of the net new corporate bond issuance in the marketplace (Chart 4). Therefore, not surprisingly, credit spreads remain near all-time tight levels.

Finally, private equity capital and hedge funds have further benefited from a structural shift in the markets, and have helped to provide fresh liquidity into the financial markets. Private equity groups announced $700 billion worth of deals in 2006, more than double the record set in 2005.1 Deal sizes are also increasing. The Blackstone Group’s recent $39 billion all-cash purchase of Equity Office Properties (EOP) attests to the liquidity private equity players now have at their disposal. Hedge fund growth has also exploded and there appears to be no near-term end in sight given that these firms are now able to come to the public markets to raise equity to grow their capital base. As an example, Fortress Investment Group LLC recently raised $634.3 million in equity through an initial public offering (IPO).2 Private equity and hedge fund investors, driven by the need to justify lofty management fees, are seeking higher returns by embracing higher risk tolerances. As we discussed in our December 2006 U.S. Credit Perspectives, Credit Innovation and Opportunity, the quest for yield has fueled rapid innovation and rising risk in the credit markets.

New pools of capital are also seeking out alternative investments. .... Goldman Sachs has benefited tremendously from these secular changes in the financial markets . Goldman Sachs is not only one of the largest global advisory firms in the world, but it is also the largest manager of hedge fund assets.3 It is a primary beneficiary of the growth in collateralized debt obligations (CDOs) and credit derivatives, which have acted to expand liquidity in the credit markets through disintermediation and innovation. Goldman Sachs has aggressively moved into private equity capital fund raising, and reportedly just raised $19 billion through a new fund, ....

The trends that have contributed to tight corporate bond spreads are having a similar effect on the U.S. stock market. The supply of new stock issuance (Chart 6) has turned sharply negative due to rising share buybacks and LBOs. This technical imbalance, combined with solid economic and corporate profit growth, has helped lift equity prices to record highs. Robust global liquidity combined with reduced supply has changed the landscape of equity investing.

Asset Prices, Risk Premiums and Financial Conditions
The global liquidity boom has its consequences. Rising asset prices are leading to easy credit conditions, which in turn are supporting economic growth, lowering volatility and compressing risk premiums. In this environment, investors with relatively short memories have embraced this recent period of economic nirvana as if it were here to last, by taking on more leverage and adding even riskier investments.

In the credit markets, the low and declining default rate has encouraged a strong propensity to take risk over the past few years. As a result, the growth in global liquidity has increasingly been funneled into higher risk asset classes such as lower-quality investment grade corporate bonds, high yield bonds, emerging market bonds, collateralized debt obligations (CDOs), real estate and equities. This trend further reduces the cost of capital to take on leverage, supports more LBOs and provides additional fuel for the equity market. In fact, LBO volumes have grown at an annualized rate of 64% from 2002-2006.5 We have not seen this type of growth in corporate re-leveraging since the late 1980s. Given these conditions, it is no wonder the Federal Reserve is sounding hawkish. Accommodative financial conditions are providing a stimulus to the economy.

While monetary conditions have tightened somewhat with a higher Fed Funds rate, credit and financial conditions remain easy. These conditions are a significant reason why Moody’s consistently has pushed back its estimates for rising default rates (Chart 7). I believe investors are underestimating the risks present in today’s low default rate environment, because today’s credit markets are significantly impacted by technical factors. I am skeptical that credit spreads are at near all-time tights because of improved fundamentals, especially given the rise in shareholder-friendly initiatives, growth in private equity and increasing occurrence of LBOs. an example where they are way too late..

Implications for Credit Investing
The liquidity-driven boom in today’s financial markets has had a significant impact on corporations. Cash continues to pile up on corporate balance sheets, and companies have never before found such easy access to capital, due to a benign credit environment and tremendous growth in the bank debt and private equity markets. Hedge fund growth has also led to strong demand for structured credit risk. These financial sponsors are flooding corporations and markets with new pools of capital. This trend helps to explain why corporate default rates have failed to rise despite projections of higher default rates. Simply put, it is hard to default when investors continue to lend money.

Despite low default rates, the credit market faces significant challenges arising from the growth in private equity and hedge fund capital. Equity-friendly measures, such as LBOs (chart 8), share buybacks, divestitures and mergers and acquisitions are on the rise. In addition, corporate profit growth is slowing, and management is beginning to re-leverage balance sheets in response to increasing pressure from hedge fund and private equity investors. As the pendulum continues to shift from bondholders to equity holders, we should expect shareholder-friendly initiatives to remain elevated.

Despite extremely tight credit spreads on investment-grade corporate bonds, investors continue to seek higher returns by investing further down the capital structure. This classic, late-cycle behavior supports the notion that we are in a liquidity-fueled market in which downside risk far exceeds potential upside returns, particularly for most investment-grade corporate bonds without covenant protection and for lower-rated, high yield bonds.

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