World-Class Corporates: A Better Risk Than Treasuries?

The balance sheets of U.S. companies and their sovereign have been heading in different directions, raising questions about corporate bond yields.
Jesse FogartyJanuary 4, 2012

Last August, Standard & Poor’s downgraded the U.S.’s once-sterling long-term credit rating from AAA to AA+, citing the rising debt burden and the “gulf between political parties.” The situation reduced S&P’s confidence in the government’s ability to manage its finances in the challenging global economic environment. The debate in Congress to raise the debt ceiling resembled the Barnum and Bailey Circus, not the leaders of the free world coming together to reach a compromise. It was the corporate equivalent of the CEO and CFO of the world’s preeminent company very openly disagreeing over the company’s business model and capital structure. Can you imagine what the equity market’s reaction would be to such an event? It certainly wasn’t characteristic of an entity deserving of the gold standard in the credit world.

How did the U.S.’s creditworthiness get dinged? Corporate America responded quite differently to the 2008–2009 financial crisis than the federal government did. To prevent the “Great Recession” from becoming a repeat of the Great Depression, the government had to act forcefully on both the fiscal and monetary fronts. This entailed having to releverage the nation’s debt, spending nearly $800 billion on the American Recovery and Reinvestment Act of 2009 in the face of falling tax receipts.

The goal of the massive stimulus was to save and create jobs and to jump-start an economy paralyzed by the near collapse of the global banking system. U.S. corporations, however, still shaken by the economic crisis and the seizure in the credit markets, retreated to the bunker. Cost control became priority number one, with companies reining in anything in the expense column, particularly labor. They also took a cautious approach to inventory rebuilding and capital expenditures.

As the economy stabilized, corporate margins and profitability surged despite subpar growth. As companies continue to fret about the sustainability of the economic rebound and lack of clarity around the macroeconomic picture in light of the European sovereign debt crisis, they continue to take a wait-and-see attitude. The result has been a massive hoarding of cash and a marked improvement of balance-sheet metrics such as liquidity and coverage ratios. That leaves corporations in terrific shape from a fundamental credit perspective.

Is it conceivable that a high-quality corporate, like McDonald’s, could trade at less of a risk premium than the mighty United States? The answer is yes, in one market. Current levels in the credit default swap (CDS) market indicate that it is more expensive to insure against a default of the U.S. government than of some high-quality U.S. firms that have large revenue bases in foreign countries.

While one market has spoken, it is important to keep its limitations in perspective. The CDS market for the U.S. sovereign is relatively small, at $29 billion net notional outstanding (compared with the market for Italy, at $300 billion). It is also somewhat illiquid. The U.S. CDS market has also been pressured by macro investors who have used it as a vehicle for a cheap “short” against systemic risk. They also use it to capitalize on increased volatility.

Is it possible for these high-quality corporate credits to fund their liabilities in the bond market for less than the government does? The answer is probably no. Despite the fact that fiscally, many corporations are headed in a different direction than the U.S. government, the government has what no company has: a printing press for money. It is improbable that superquality names will trade with less yield than “risk-free” Treasuries. But for investors, this is a great opportunity to invest in world-class companies and get some yield in a no-yield world.

Jesse L. Fogarty, CFA, FRM, is a managing director at Cutwater Asset Management. He is responsible for investment-grade credit-portfolio management and trading across all managed accounts, with a primary focus on liability-driven investing products.

DISCLAIMER: The opinions expressed in this article are solely those of Cutwater Asset Management. All information presented is believed to be reliable, however the accuracy, timeliness, and completeness of the content is not guaranteed and should not be relied upon as a basis for any investment decision. This article does not constitute investment advice and Cutwater Asset Management disclaims any liability for any use of the content thereof.