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IS THE CUT IN LEVERAGE GOOD FOR THE ECONOMY?

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By Meziane Lasfer 

The Wall Street Journal dated 4th March stated that 216 non-financial companies in the S&P 500 cut their debt-to-capitalisation ratio in the past year from 43% in 2012 to 35.4% in 2013. Even though this ratio, measured as debt over the sum of debt and shareholder equity (it wasn’t clear as to whether this is at market or book value), is higher than 35.4% in 2011, it indicates that firms are relying less on debt finance. On the face of it, the fact that so many companies cut their debt might be good news, as they reduced their financial risk. It suggests that they may have been in the past over levered with potential difficulties of servicing their debt, and the reduction in debt is likely to lead to safer firms and financial markets, and may result in an increase in growth.

However, we cannot be certain that this is the case, particularly if this decrease in debt is due to the following factors:

Meziane Lasfer

Meziane Lasfer

Firstly, a lack of investment opportunities. Companies may have decreased their debt because they do have any good investments. Worst, it could be that firms are in declining stage of their life cycle, and, therefore, they use their cash to pay back their debt. However, the overall trend in the US stock market appears to indicate the other way, i.e., that companies are at growth. Are companies giving different signals from the stock market? Is the money returned to debt holders going to find a way to the stock market and lead to a stock market bubble?

Secondly, debt holder monitoring: the decrease in leverage may indicate that firms are running away from debt-holder activism, and since shareholders do not have significant power to monitor managers, the reduction in debt will lead to an increase in the agency conflicts. Consequently, the future growth is hampered.

Thirdly, excess cash: are firms still growing but are they using cash to undertake their investments, because it has low transaction and monitoring costs? In this case, why don’t they use the cash to buyback more shares instead of reducing their debt? By reducing their debt, they are likely to increase their cost of capital, and therefore, reduce their growth.

Fourthly, taxation: are firms expecting a reduction in the corporate tax rates or in the proportion of interest that can be set against the tax, thus lowering the debt tax shields?

Finally, bankruptcy costs: Are firms expecting an increase in the bankruptcy risk, thus, lowing of their credit ratings and signaling bad times to come?

Overall, the information is ambiguous. In order to understand what is happening, and to assess fully whether this is good or bad for the economy, we need much deeper analysis of the reasons underlying this decrease in debt financing.

About the Author

Meziane is Professor of Finance at Cass Business School, City University London. His research interests include Corporate Finance, Governance and Capital Markets. He has published widely in top international academic journals such as Journal of Finance, Journal of Finance and Quantitative Analysis, Journal of Banking and Finance, Journal of Corporate Finance, Financial Management, European Financial Management, and National Tax Journal. His research was widely reported in the press and was sponsored by the National Association of Pension Funds (NAPF), the Finance Lease Association (FLA), Morley Asset Management, ICAEW, Donaldsons and Land Securities-Trillium. He is ranked among the top 20 top researchers in Europe*.  Full Profile

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Oil gains as U.S. fuel stocks drop, OPEC+ considers deal rollover

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Oil gains as U.S. fuel stocks drop, OPEC+ considers deal rollover 1

By Stephanie Kelly

NEW YORK (Reuters) – Oil prices rose more than 2% on Wednesday, boosted by a huge drop in U.S. fuel inventories and expectations that OPEC+ producers might decide against increasing output when they meet this week.

U.S. gasoline stocks fell last week by the most on record and refining output fell to a record low in the wake of a deep freeze in Texas that shut production.

Gasoline inventories fell to 243.5 million barrels, the U.S. Energy Information Administration said, while distillate stockpiles fell by the most since 2003 to 143 million barrels.

“This drop is 100% based upon the storm in Texas,” said John Kilduff, partner at Again Capital Markets in New York. “It froze up the entire Texas supply chain and caused a drawdown on available refined product stores.”

Crude inventories rose by 21.6 million barrels, the most on record, to 484.6 million barrels, EIA said. Refining capacity use fell to just 56% of overall capacity, the lowest on record, as the U.S. Gulf Coast’s refining capacity use plunged to 40.9%, the lowest ever.

Brent crude rose $1.30, or 2.1%, to $64.00 a barrel, a 2.1 percent gain by 11:11 a.m. EST (1611 GMT). U.S. West Texas Intermediate (WTI) crude rose $1.55, or 2.6%, to $61.30 a barrel.

Oil prices earlier jumped after Reuters, citing three sources, reported that the OPEC+ group comprising the Organization of the Petroleum Exporting Countries and allies including Russia is considering rolling over production cuts from March into April rather than raising output.

The group had previously been widely expected to ease the production cuts when it meets on Thursday.

Kuwaiti Oil Minister Mohammad al-Fares said the market was being supported by optimism over vaccinations.

Also positive for prices, U.S. President Joe Biden said the United States would have enough COVID-19 vaccines for every American adult by the end of May after Merck & Co agreed to make rival Johnson & Johnson’s inoculation.

Biden said he hoped that the United States would be “back to normal” at this time next year and potentially sooner.

(Reporting by Stephanie Kelly in New York; additional reporting by Bozorgmehr Sharafedin in London and Shu Zhang and Sonali Paul in Singapore; Editing by Edmund Blair and David Goodman)

 

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Stocks edge down as investors hit pause, watch bond yields

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Stocks edge down as investors hit pause, watch bond yields 2

By Suzanne Barlyn

NEW YORK (Reuters) – Global equity markets were little changed on Tuesday as Wall Street retreated and investors paused to gauge whether a bond yield jump had run its course, taking stock of gains from Monday’s surge.

The subdued performance of the three major Wall Street indices followed a flat close in Europe and slipping shares in Asia.

“It was such a strong opening to the month yesterday that investors could be short-term focused and saying, ‘Let’s take some of the profits that we saw yesterday,'” said Sam Stovall, chief investment strategist at CFRA Research in New York.

March began with a bang on Monday as global equities markets rose, the S&P 500 had its best day since June 5 and bond markets calmed after a month-long selloff.

In Tuesday late-afternoon trading, the Dow Jones Industrial Average rose 45.37 points, or 0.14%, to 31,580.88, the S&P 500 lost 3.1 points, or 0.08%, to 3,898.72 and the Nasdaq Composite dropped 106.23 points, or 0.78%, to 13,482.60.

The pan-European STOXX 600 index rose 0.19% while MSCI’s gauge of stocks across the globe %.

Emerging market stocks rose 0.05%. MSCI’s broadest index of Asia-Pacific shares outside Japan closed 0.16% lower, while Japan’s Nikkei lost 0.86%.

The European Central Bank should expand bond purchases or even increase the quota earmarked for them if needed to keep yields down, ECB board member Fabio Panetta said on Tuesday, after weeks of steady increases in borrowing costs.

Australia’s central bank on Tuesday affirmed its pledge to keep interest rates at historic lows as policymakers battle to stop surging bond yields from disrupting the country’s surprisingly strong economic recovery.

After a sharp selloff last week, U.S. Treasuries have stabilized with bond market indicators and derivatives positioning pointing to near-term calm. But an improving economy could trigger another slide in their prices.

U.S. Federal Reserve Governor Lael Brainard said she was closely watching bond markets and would be concerned if a recent rise in yields continued and began to constrain economic activity.

“Some of those moves last week and the speed of the moves caught my eye,” Brainard said on Tuesday.

A Treasuries selloff last week pushed the 10-year yield to a one-year high of 1.614%. Benchmark 10-year notes last rose 11/32 in price to yield 1.4102%, from 1.446% late on Monday.

Gold prices rose, inching up from a more than eight-month low, as a retreat in the dollar and U.S. Treasury yields lifted demand for the safe-haven metal.

Spot gold added 0.8% to $1,736.02 an ounce. U.S. gold futures settled up 0.6% at $1,733.60.

The dollar index fell 0.318%, with the euro up 0.37% to $1.2092.

Earlier, the dollar was up for a fourth consecutive day after the spike in bond yields challenged the market consensus for dollar weakness in 2021. But riskier currencies rose as bond markets calmed and stocks recovered.

Bitcoin fell 2.19% to $47,808.00 after rising nearly 7% on Monday.

Shares in mainland China and Hong Kong fell overnight after a top regulatory official expressed concerns about the risk of bubbles bursting in foreign markets.

Oil prices largely shrugged off expectations that OPEC would agree to raise oil supplies at a meeting this week.

The global oil market is rebalancing after damage to demand wrought by the COVID-19 pandemic was met with curbs on output by OPEC producers, the group’s president said.

The industry is recovering from a collapse in demand triggered by the pandemic, but U.S. shale production will not recover to pre-pandemic levels, Occidental Petroleum Chief Executive Vicki Hollub said on Tuesday.

“The recovery is looking really good to us. If you look at what’s happening in India as well as the U.S., I think the oil industry is looking like things will be pretty good for us over next couple of years,” Hollub said.

U.S. crude futures settled down 89 cents at $59.75 a barrel, while Brent futures fell 99 cents to settle at $62.70 a barrel.

(Reporting by Suzanne Barlyn; Editing by Dan Grebler)

 

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Robinhood now a go-to for young investors and short sellers

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Robinhood now a go-to for young investors and short sellers 3

By John McCrank

NEW YORK (Reuters) – Robinhood, the online brokerage used by many retail traders to pile in to heavily shorted stocks like GameStop Corp, has made an ambitious push into loaning out its clients’ shares to short sellers as it expands its business.

The broker had $1.9 billion in shares loaned out as of Dec. 31, nearly three times the $674 million a year earlier, and it was permitted to lend out $4.6 billion worth of securities under margin agreements, around five times bigger than the prior year, according to an annual regulatory filing late on Monday.

The size of the jump highlights Robinhood’s rapid growth over the past year as the number of retail investors has soared in the work-from-home environment during the pandemic and as retail brokers have largely eliminated trading fees, a model Robinhood helped pioneer.

Menlo Park, California-based Robinhood is expected to go public this year with a valuation of more than $20 billion.

Securities lending is common among brokerages, which can earn income by lending shares to hedge funds and others, who then sell the shares back into the market, betting the share prices will drop so they can buy them back at a lower price when it is time to return them, pocketing the difference.

Shares that are in heavy demand from short sellers, like GameStop, which had 140% short interest in January https://www.reuters.com/article/us-retail-trading-shortselling-explainer/explainer-how-were-more-than-100-of-gamestops-shares-shorted-idUSKBN2AI2DD, command the biggest premium from the lender.

What makes Robinhood notable is that many of the stocks its users invest in are among the most sought-after by people who want to bet against them, said one senior financial executive involved with hedge funds.

It was unclear how great a benefit the securities lending was to Robinhood’s revenue and income, which it does not disclose.

Robinhood declined comment on the filing and did not immediately respond to a request for comment on the details of which stocks it loans out.

In January, retail investors coordinated through trading forums on social media in an attempt to punish hedge funds by buying up shares of GameStop and other heavily shorted names, like AMC Entertainment, driving up their prices and forcing short sellers to close out positions at big losses.

On Jan. 28, at the height of the retail trading mania, Robinhood, along with several other brokers, restricted the buying of GameStop and other so-called meme stocks due to a massive spike in collateral requirements needed to clear the trades, angering many of its customers.

The trading restrictions sparked congressional hearings, regulatory probes and have placed greater scrutiny on short selling.

In response, Vlad Tenev, Robinhood’s chief executive officer, called for shorter stock settlement times, which would reduce clearing collateral requirements.

He also said the idea that more shares of a stock can be shorted than there are available to trade, as was the case with GameStop, is a “pathology” that could destabilize the financial markets.

Robinhood positioned itself for growth in securities lending in October 2018 by launching its own clearing broker, which acts as a go-between with the clearinghouse that settles its trades, and allows it to hold its customers’ assets. The broker can then lend out securities its customers buy on margin.

At present, less than 3% of Robinhood’s funded accounts are margin-enabled, Tenev recently told Congress.

(Reporting by John McCrank in New York; Editing by Megan Davies and Matthew Lewis)

 

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