Thursday December 22

Stocks fell as activity starts to get light leading into the holiday weekend and the end of the year. The S&P 500 fell 0.2% to 2,260 and the Dow Jones fell 0.1% to 19,918. Consumer discretionary shares were the biggest underperformers with declines led by Bed Bath & Beyond after reporting bad earnings earlier this week. Energy shares rose on higher oil prices. Economic data today showed that new durable goods orders fell more than expected, however excluding transportations new orders rose 0.5% compared to estimates of 0.2%. Additionally third quarter GDP was revised upward from 3.2% to 3.5% which was above expectations. Additionally PCE data showed that personal income was unchanged over the month versus expectations for a 0.3% increase. Additionally spending rose 0.2% missing expectations by 0.1%. The PCE price index was unchanged on the month missing expectations by 0.2%. The data brings the PCE Price Index to a yearly change of 1.4% which is still well short of the Fed’s target.  Additionally BMPS shares in Italy fell 7.5% even after the Italian government put together a EUR 20bn fund to rescue the financial sector. Additionally the Italian 10 year yield rose 4bp to 1.86%. On that backdrop the 2 year US Treasury yield fell 1bp to 1.20%. The 10 year yield rose 1bp to 2.55%. USD fell 0.1% against EUR to $1.0436. USD was unchanged against JPY to Y117.51. WTI rose 0.3% to $52.65. Brent rose 1.1% to $55.05.

KKR is seeking to liquidate a stake in a water sewer entity that supplies water to Bayonne in NJ and Middletown in PA. Whether or not the private equity company is able to sell its stake in the infrastructure project will have potential implications on Trump’s infrastructure plans. Trump has roughly outlined plans for $1tn in infrastructure spending financed by private investors, however private investors will only be able to contribute the capital if they are able to do so profitably. In doing so they are looking towards the few examples of past infrastructure investment projects. KKR invested around $175mm into these projects and committed more than $200mm for repairs and maintenance over the next four decades. In return they are set to receive revenues from billing customers of the water sewer company. The investment will be marketed to insurance companies and pension plans who have long term liabilities and are seeking steady returns. Investors are already looking to raise public infrastructure funds given Trump’s campaign talks, and have put up a record $57.5bn to invest in the sector. Carlyle has had two similar projects in the past and executed them profitably, however they had to fight in the courts with the municipalities suing that Carlyle underspent in maintenance and repairs. Some municipal officials have claimed that as a result of Carlyle’s deals water rates have risen too much. KKR negotiated terms for years with regulators, and a contractual cap on KKR’s profits helps avoid some of the problems Carlyle ran into. Investors are guaranteed a minimum revenue that increases at a 4% rate as well as a lifetime cap if revenue rises above projections.

High yield bonds have been in demand from investors towards the end of this year. While many investors have shifted out of fixed income and into equities after the election response, many have shifted into high yield as well. It is expected that tax reform and improving economic growth will especially benefit junk rated companies compared to their investment grade counterparts. The recent rally in oil prices too is also contributing to this trend. High yield energy bonds have returned 37% year to date. High yield as a whole has returned more than 16% this year. The outlook for 2017 is also bright as many analysts expect that defaults will decrease. Fitch expects that the 12 month default rate for junk rated energy companies will fall from 18.8% this past November to 3% by the end of next year. Technicals also have been driving the market as supply is expected to fall. Trump has proposed removing interest as a tax deductible expense which would decrease high yield issuance. This could reduce the size of the overall high yield universe. Spreads have tightened since the election indicating that although interest rates have risen, investors are increasingly willing to take credit risk.

Thursday December 22

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