Junk rally slows along with activity level, Rite Aid up modestly; Sprint off gains; funds drop

By Paul Deckelman and Paul A. Harris

New York, Sept. 1 - The high-yield market's three-session rally seemed to weaken on Thursday, its momentum slowing along with activity levels in Junkbondland, as market participants cleaned up their loose ends ahead of what is expected to be an extremely slow pre-holiday session on Friday.

Rather than firming by multiple points, as was the case for many issues on Wednesday, junk bonds notched much smaller gains on Thursday - if even rising at all.

Statistical measures of market performance were seen having turned mixed after three straight days on the upside, particularly on Wednesday when they had turned in a strong showing. Stocks, , , meanwhile,,, which are seen by some in the market as a proxy for risk assets, including junk bonds, had their first down day after four straight sessions on top, hurt by weakness in financial names.

Among specific names, GAP Inc.'s bonds, which have fans in both the junk and the high-grade markets due to the apparel retailer's split rating, were seen down by at least a point in very busy dealings after its August sales numbers proved to be disappointing.

Among the purely junk credits, Rite Aid Corp., whose bonds had popped on Wednesday ahead of Thursday's release of August sales data, were moderately higher after the drugstore operator did, in fact, post better sales figures.

But Sprint Nextel Corp.'s paper was seen mostly eased versus Wednesday, when the bonds had firmed on news that federal regulators will attempt to stop the merger of two Sprint rivals, AT&T and T-Mobile.

And despite recent strength in the junk realm, including Wednesday's solid gains, high-yield mutual funds, seen as a gauge of overall market liquidity trends, showed a downturn for a fifth consecutive week.

AMG: Funds off by $96 million

As Thursday's session was winding down, market participants familiar with the weekly AMG high-yield mutual fund flow statistics generated by Lipper/FMI said that in the week ended Wednesday, $96.44 million more left those weekly reporting funds than came into them.

It was the fifth consecutive week during which the funds were seen suffering a net loss of cash, immediately following the $126.73 million outflow seen in the week ended Aug. 24.

Over that five-week period stretching back to the week ended Aug. 3, which included the staggering $3.42 billion hemorrhage in the week ended Aug. 10, the second-biggest such outflow on record, the funds have tallied a net loss of some $4.854 billion, according to a Prospect News analysis of the numbers. That more than offset the roughly $2.775 billion, which had come into the funds in the four weeks before that dating back to the week ended July 6, according to the analysis.

For the year as a whole, although inflows have still been seen in 21 weeks versus 14 outflows, the momentum has clearly shifted in the other direction when it comes to year-to-date net totals. While at one point year-to-date net inflows had totaled as much as $7.82 billion, which was recorded in the week ended May 25, according to the analysis, the recent string of sizable outflows has now driven the year-to-date figure into the red. The overall net outflow for the year so far worsened this week to an estimated $574.91 million from the previous week's $478.47 million.

Fund-flow patterns began the new year on a roll with cash infusions totaling more than $8 billion seen over a 14-week stretch from early December through mid-March, including the more than $6 billion taken in during the first 10 weeks of this year. Then, fund-flow patterns turned choppy, with two or three weeks of declines, followed by several weeks of inflows, going back and forth since then. But after July's prospective break to the upside, August was a complete wipeout.

EPFR $328 million outflow

Another fund-tracking service, Cambridge, Mass.-based EPFR Global, whose methodology differs from AMG, reported a $328 million outflow from the funds in the latest week.

That cash loss followed last week's $937.6 million cash bleed, a big loss in its own right, but one which followed - and was overshadowed by a pair of mammoth losses - $2.21 billion in the week ended Aug. 17 and the $6.71 billion outflow recorded in the Aug. 10th week. This was the single largest loss of cash from those funds since EPFR began tracking fund flows some years ago, nearly twice the size of the previous record loss: $3.51 billion in the week ended June 22.

It was the fifth consecutive week that EPFR's numbers were on the downside, and the 10th time in the past 13 weeks that it had seen more money exiting the funds than was being put into them. Its calculations now show 23 weeks of inflows so far this year against 12 outflows.

The latest week's cash loss produced an estimated year-to-date net outflow of $1.458 billion.

EPFR's figures and those of AMG generally point in the same direction, although their actual numbers usually differ markedly since they calculate their respective fund-flow totals very differently. EPFR, for instance, includes results from non-U.S. domiciled funds as well as the domestic funds and counts exchange-traded funds excluded from the more narrowly focused AMG tally.

Cumulative fund-flow estimates, whether from Lipper/FMI or EPFR, may be revised upward or downward or be rounded off and could include unannounced revisions and adjustments to figures from prior weeks.

Analysts say the continued flow of fresh cash into junk - and the mutual funds represent but a small, though observable and quantifiable percentage of the total amount of money coming in - fueled the record new deal borrowing binges seen in both 2009 and then in 2010 as well as the robust secondary market seen both years. Those trends had pretty much continued into 2011 as well, although the market hit something of a dry patch in June, then seemed to recover in July - only to run into a brick wall for all of August.

While the outflows reported by both AMG and EPFR were clearly smaller than those seen the week before, they still were in negative territory, a sign that the junk market still has a ways to go after trying over the last few sessions to battle back from the positively deadly toxic August it suffered in the wake of volatility arising from the U.S. debt-ceiling battle and the first ever downgrade of America's credit rating, which followed that messy process.

A trader had noted that on Tuesday, the daily fund-flow number from EPFR had finished in the black "for the first time in a couple of weeks" and with Wednesday's clear gains in the junk market, "it looks like those fund flows may shift a little bit," though obviously not far enough.

Seeing improvement

The primary market remained becalmed on Thursday. Conditions, however, in high yield are improving, market sources say.

Levels have moved two points to four points higher in the past two days, a mutual fund manager said.

"It looks as though we might be set to rally, a little bit, and people are trying to get in front of that," the buy-sider added.

Chrysler Group LLC's 8¼% notes due 2021 were 87 bid at Thursday's close. That's up from 80 bid, 81 offered on Monday, the investor said. The $1.7 billion issue priced at par in May.

The notes were oversold for technical reasons, the investor said.

"When you have to raise cash quickly, you are forced to sell the on-the-run names: the Freescales, the HCAs and the Chryslers.

"You're not going to raise a lot of cash quickly by trying to sell the triple Cs," the source added.

Sooner rather than later

During the Thursday, session the dealers began expressing confidence that the primary market will reactivate during the post-Labor Day week.

Sources mentioned visibility on deals for the week ahead, but declined to furnish names.

Among several committed LBO financings on the forward calendar, Sealed Air Corp.'s $1.5 billion equivalent of senior notes, via Citigroup, is a decent bet for the post-Labor Day week, sources said on Thursday.

"I think you're going to hear some deal announcements earlier than people are anticipating," a debt capital markets banker said.

That theme recurred in several conversations with market sources on Thursday: In the post-Labor Day market, deals will be rolled out sooner than later.

All told, 2011 could still see a dramatic finish, according to a market source who alluded to a note from JP Morgan anticipating $74 billion of additional issuance before the end of the year.

There is an $11 billion to $12 billion pipeline of committed financings in the works for the September-October time frame, a syndicate banker said.

Things could turn quickly

Since the market correction got under way in late July, junk widened by around 100 basis points, a fund manager said on Thursday.

"We've plowed back about one-quarter of that amount," the buysider added.

Now that the massive outflows have abated, things are apt to turn around quickly, the fund manager said.

"We could even see a mini-rally here, but I don't necessarily think that would be such a great thing."

For the committed financing deals, the market will be open, but the bonds are going to have to be priced to sell, the manager asserted.

"It's extremely important that people see some strong performance out of the first couple of deals that price," the investor said.

As to potential opportunistic issuers looking to refinance debt, doing a deal at present levels probably still does not make sense.

The market quiets down

A secondary trader, asked whether the change of months over to September meant that activity levels were now picking up or whether everyone was just cleaning things up and getting squared away ahead of the upcoming three-day holiday break, unhesitatingly chose the latter option.

"There was nothing too exciting going on in many of our names," he declared.

"Speaking to people today, it seems like half of the folks are taking today and [Friday] off, while the rest are kind of taking Friday and Tuesday off. So places are, and will be, kind of lightly staffed, wherever and everywhere you talk to.

"It was just one of those pre-holiday days, here," he stated.

While Friday is officially a full session - the Securities Industry and Financial Markets Association did away with the traditional pre-Labor Day early market close recommendation several years ago - the reality, traders said, is that it promises to be a really slow one ahead of Monday's full-day market close for Labor Day.

"It's really slowing up," another trader said. "This is definitely a 'disappearing week.'

He cited the famous "parking-lot indicator:" Parking spaces at suburban commuter railroad stations closer to the actual building and train platforms are much more available than usual.

As another item of unofficial proof that things had already slowed down with a great many people out, he said, "When you call [different bond shops], there's different people on the desk" - a sign that the senior people in a position to make decisions are instead off at the beach or playing golf.

"And it's the same on the client side, which just leads to inactivity."

Jobs data awaited

A trader at another desk said that however quiet it is, Friday's session will have a big piece of news to chew on, "the 400-pound gorilla: non-farms."

The Labor Department is scheduled to release its monthly assessment on job creation within the economy, the gain or decline in non-farm payrolls during the month of August, as well as the nominal unemployment rate.

"Depending on what the employment situation looks like," he said, "that has the potential to derail some of the market enthusiasm" seen over the previous several sessions - although he allowed that "obviously, if we get any strength out of that, it just as adds fuel to the fire."

Forecasters are "guestimating" on average that the non-farm jobs number will likely come in at around 90,000, while a slightly lower figure of between 40,000 and 70,000 is quite possible and should not be a surprise. Some forecasters are not even that optimistic and predict that the net payrolls figure will actually show a loss of jobs.

There are also widely varying estimates as to the number of private-industry jobs, as opposed to government jobs, that will have been created.

July's number was 117,000 - better than the predicted 90,000, but still well below the 250,000 new jobs a month, which many mainstream economists have warned that the economy needs in order to get out of its current rut.

'Better buying'

A trader saw "better buying" during Wednesday's session and Thursday, although he raised the possibility that a bearish non-farm payrolls number might bring that trend to a halt.

He said that the market was helped by the fact that "inventories have gotten rather lean. It is difficult, clearly, to find any type of sizable offering at this point in time."

He said the downturns in the early part of the month forced many accounts to get rid of positions in a lot of different names, "so now you're at the point where people are out of stuff, the balance sheets are light and now you've got buyers again."

Market indicators turn mixed

Statistical indicators of market performance, which have been up the past three sessions since Friday's downturn, turned mixed on Thursday.

A trader saw the CDX North American Series 16 HY Index lose 5/8 of a point on Thursday to end at 94¼ bid, 94½ offered, after having gained 7/8 of a point on Wednesday.

But the KDP High Yield Daily Index rose by 16 basis points on Thursday to finish at 72.73, on top of Wednesday's eye-opening 62-bps jump. Its yield came in by 7 bps to 7.64%, after having tightened by a whopping 20 bps on Wednesday.

After three straight sessions of having moved in tandem, stocks and junk bonds once more diverged. While high yield retained a mixed-to-positive tone, equities slid on investor worries about the financial sector after regulators took action against a former Goldman Sachs subsidiary over its mortgage and foreclosure practices.

The bellwether Dow Jones industrial average ended down 119.96 points, or 1.03%, at 11,493.57, slipping back into the red for the year the full year. Broader indices were also down, with the Standard & Poor's 500 off 1.19% on the day and the Nasdaq Composite 1.30% weaker.

Gap gets slapped

Among specific issues, a trader saw Gap's 5.95% notes due 2021 as the volume leader, off by 1 point at 95 bid on turnover of over $33 million. It was tops in the junk market, although some of the buying likely came from high-grade accounts - Moody's and Fitch peg the name as high grade but S&P still carries it as junk.

The bonds slipped after the San Francisco-based apparel retailer reported that same-store sales fell a worse-than-expected 6% across all brands in August 2011, particularly at its eponymous flagship store operation, where the comps slid by 8% versus a 1% decline in the year-ago month.

Rite Aid rally continues

A trader saw Rite Aid's bonds better, as the Camp Hill, Pa.-based drugstore chain operator reported improved sales numbers for August, helped by, among other factors, customers coming in and buying non-pharmacy items - "front-end" merchandise, as it's known in the drugstore industry - in preparation for Hurricane Irene, especially in the Northeastern United States, where Rite Aid has 35% of its stores, a heavier exposure than rivals CVS Caremark Corp. and Walgreen Co.

Rite Aid reported a 2.5% gain in same-store sales versus a year ago.

The trader saw the company's 10 3/8% notes due 2016 up three-quarters of a point, trading at 105¾ bid, while its 9 3/8% notes due 2015 were up one-quarter point, at 90¾ bid, while the rest of the company's issues "had real small pieces trading."

A second trader quoted the company's 9½% notes due 2017 finishing the day at 88¼ bid, 88½ offered, which he said was probably up three-quarters of a point, "or call it a point." He said that "literally, there were just one or two trades in the name."

He said the 10 3/8s were at 105½ bid, 106 offered, which he said was up by three-quarters of a point, with "some trading, but I'm not seeing a lot of activity."

Between those two issues, "there's three trades, and it didn't look like even $5 million of bonds traded."

He further saw the 8 5/8% notes due 2015, which had been the busiest Rite Aid bond on Wednesday when about $14 million changed hands, moving around the 90-91 area and up by several points. He said that they were still in a 91-91½ context, but noted that there was "really no activity. It was a really small amount, just small trades in that."

The first trader was a little skeptical of the theory that the hurricane boosted sales by very much, stating: "I don't know how much of a bump you'd get from that.

"I can't see doing my grocery shopping at Rite Aid, because it's so much more expensive than going to the grocery store - unless the grocery store is out of food" or items that consumers buy heavily ahead of a storm, like bottled water or flashlight batteries.

Sprint steps back

A trader saw Sprint Nextel's bonds - up solidly on Wednesday on the news that the federal government is trying to block the pending merger of Sprint rivals AT&T and T-Mobile - "for the most part down slightly" from one-eighth to one-quarter point.

While he saw the Overland Park, Kan.-based No. 3 U.S. wireless operator's 7 3/8% notes due 2015 actually up by one-quarter of a point at 98¾ bid, he said "that was the one issue that was up slightly."

More typical, he observed Sprint's 6 7/8% notes due 2028 down a half-point, at 90 bid.

"With all of the others, there's not large volume to talk about," he declared.

Another market source, meantime, saw the 7 3/8s ending the day around 991/2, but said that was down nearly a point.

Harrah's gets hit

A trader saw Caesars' Entertainment Corp. - the Las Vegas gaming giant more familiarly known under its old name of Harrah's - off on the session, after having notched respectable gains. He quoted the bonds as having dipped to 77 bid, calling that down 1½ points on the day.

Another market source pegged the bonds at 77 bid, calling them down 1½ points, on fairly brisk volume of about $9 million.

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