Investors waiting for Fed, sit still except for large bid on Raymond James’ best picks

By Emma Trincal

New York, Dec. 16 – Investors were on hold last week waiting for the much anticipated move by the Federal Reserve on interest rates. In the event, the central bank decided on a 25 basis points increase.

“Investors were not in a rush to put their money to work last week given the looming Fed verdict and the overall market volatility,” said a structured note trader.

Agents sold $383 million in 71 deals in the week ended Friday, according to data compiled by Prospect News. It was nearly a third less than in the previous week, which, as the first of the month, was not even supposed to be strong according to the monthly calendar cycle. The number of deals last week fell by half, to 71 from 144 the week before.

If it was not for a $165 million Bank of Montreal deal, which gave investors exposure to a basket of stocks picked by a well-recognized equity research shop, volume would have been at record lows.

“The market is doing nothing. What you gonna do?” said the structured note trader.

“People are just waiting for the Fed to raise rates. They’re sitting on the sidelines.”

Waiting for Yellen

At 2 p.m. on Wednesday the Fed announced a 25 basis points increase in the Federal funds rate, ending nearly a decade of zero-interest rates.

But last week, most investors were in a wait-and-see mode, said the trader.

In the overall market, crude oil prices breaking below $36 a barrel last week coupled with hedge fund Third Avenue Management LLC’s liquidation of its high-yield bond fund Third Avenue Focus Credit fund rattled the junk bond market and increased investors’ nervousness.

“You could see a cycle of forced selling in high yield,” he said.

The Fed hike everyone anticipated could flatten the yield curve a little more, he predicted, although, he added, the curve is already flat. The spread between the 30-year and the two-year bonds, he noted, is “near the flattest” for this year.

Long term, a Fed rate increase could be positive for the structured products market, he said.

“It may help issuance. It gives issuers the ability to show better terms as the funding rates will go higher.”

Timing the economy

While the vast majority of people expected the rate hike, a lot of economists warned that it is a mistake, he said.

“It’s a tremendous contradiction and it has probably been holding back a lot of investors.”

However, he drew a line between institutional and retail markets. While institutions have to focus on the Fed, individual investors should not, in his view.

“The market was on a standstill last week. Everyone had their eyes on the Fed,” he said.

“But a retail investor has no reason to care about what the Fed is going to do. They should only be concerned about their investment goals. I worry when I see retail investors picking the market as if they were trading. That’s a slippery slope.”

Regardless of the Fed’s decision, which last week was still unknown, the economic picture was not encouraging, he said, which may have also been a factor behind last week’s low volume.

“People are worried one way or the other,” he said.

“A lot of people are looking for work. It hurts the economy. People are putting off purchases. It hurts the economy. You have terrorist attacks. It hurts the economy.

“When it comes to managing money, you can’t be looking at the glass half-full and not looking at the glass half empty.

“Look, I’m not Dr. Gloom. But this is not a happy, happy time of the year.”

Credit is back

A market participant was not convinced that the Fed was a major investment theme last week let alone that it may have been a concern for structured note investors.

“Everybody anticipated the rate hike. I don’t think it had any impact in our market. The Fed move was already priced in,” he said.

The high-yield bond selloff has raised fears about credit quality. But this market participant downplayed the potential reemergence of the kind of credit quality concerns among structured note buyers that prevailed in the aftermath of Lehman Brothers’ demise in 2008.

“It will have an implication in the overall market. People are getting aware again that if you buy a risky asset you have to look at the liquidity. Low-rated bonds, particularly energy bonds are getting crushed,” this market participant said.

“That said, I don’t think structured note investors are going to get spooked by credit ratings unless the selloff spreads out to other sectors or to the equity markets. Right now it’s contained in the energy sector. In 2008, it was all over,” he said.

BMO blockbuster

Twice a year, Bank of Montreal brings to market a large offering of tracker notes linked to a basket of best stock picks selected by the equity analysts of Raymond James & Associates. The first issue hits the market in December after the analysts determine their best picks for the upcoming year. A second offering of a comparable size follows in January each year.

Bank of Montreal saved the week for structured products when it priced on Tuesday $165 million of 0% notes due Dec. 19, 2016 linked to Raymond James Analysts’ Best Picks for 2016. The 14 stock components included well-known names such as Allstate Corp, Halliburton Co., Lazard Ltd. and Microsoft Corp.

“It makes sense. If you’re going to pick stocks, that’s the way to go. You might as well choose analysts that have good track records,” said the trader.

The No. 2 deal was HSBC USA Inc.’s $43.18 million of five-year autocallable market-linked step-up notes linked to the Euro Stoxx 50 index. The annual call premium is 12% per year, triggered if the index is at or above the initial price. The step-up payment at maturity is 50% of the initial price allowing investors to outperform if the average annual positive return of the index is below 10%. Investors are exposed to any index decline.

Banking on banks

After those two deals, offerings fell below the $20 million threshold. Despite its size, the fourth structure was notable as its underlier, a sector index, has only been used once this year in a small $1.43 million deal priced by Goldman Sachs.

JPMorgan Chase & Co.’s $9.47 million of 13-month capped enhanced participation notes was linked to the S&P Banks Select Industry index. The payout is two times the positive index return up to a 17.70% cap. Investors have full downside exposure.

“People have become bullish on banks because higher rates will increase margins in the financial sector,” said the market participant.

Goldman Sachs is preparing a deal on behalf of Toronto-Dominion Bank, also designed for financial bulls. But its relative value payout gives them a little bit more room to be wrong, suggested the market participant.

The Canadian issuer will price this month 13- to 15-month leveraged capped relative performance securities linked to the S&P Banks Select Industry index and S&P 500 index.

The S&P Banks will be the long index and the S&P 500, the short index.

The return will be two times the difference between the long and the short index return up to a cap set to fall between 8.2% and 9.6%.

“It’s an interesting play. People are bullish on banks. But you’re better off making it a relative value play. That way you’re only betting that banks will outperform the market. Say the S&P is down 10% and the bank index falls 5%, you still get a positive return.

“It’s most likely a bespoke deal...My guess is that one adviser asked for it for a client.”

Overall the top agent was BMO Capital Markets Corp. with 43% of the volume thanks to its large Raymond James deal.

It was followed by Bank of America and Barclays.

© 2015 Prospect News.
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