HARBERT HEADLINES MAY 6, 2015 RAYMOND J. HARBERT COLLEGE OF BUSINESS

Federal Reserve: Junk Bond Markets Indicating Weaknesses in United States' Equities

Concerns among many investors increased as analysis via the Fed* revealed rather overpriced US equities according to comments from Fed Chair, Janet Yellen. She expressed her views with a frank speech regarding global and domestic economic conditions, forecasts, and actions that many financiers found uncharacteristic compared to her historically timid and calculated policy announcements. Yellen specified, “I would highlight that equity market valuations at this point, generally, are quite high… There are potential dangers there."

*The Fed- The Federal Reserve **US markets- The New York Stock Exchange, S&P 500, and NASDAQ !1

Finance &

Economics News + Opinion

Mark Stafford @markstafford787

FEDERAL RESERVE: STOCK VALUATIONS ARE “QUITE HIGH”

ECONOMY

RECENT OIL RALLY MAY HAVE PEAKED

COMMODITIES

TESLA UNVEILS POWERWALL INNOVATION

Federal Reserve Chair, Janet Yellen, warns of danger in US stocks today.

HARBERT HEADLINES

HARBERT HEADLINES MAY 6, 2015 RAYMOND J. HARBERT COLLEGE OF BUSINESS

Junk Bonds and the Chase for Yield Many, if not, most trading volume is generated by middle-market firms such as Cliffs Natural Resources and Capital Product Partners, which are currently struggling to attract lenders according to Bloomberg Business—making clear the reasons as to why many investors are treading carefully. Especially in regard to junk bonds and the Fed's imminent increase of what are now historically depressed interest rates.

Junk bonds are issued by firms that require capital yet do not carry a market favorable credit rating from fiscal monitoring agencies like Standard & Poor’s and Moody's. As a result, in order to attract capital (primarily for operating and expansionary functions), yield for junk bonds is typically priced at a premium to offset the increased risk and incentivize potential bondholders. A recent and broad increase in market liquidity related to quantitative easing (QE) has fueled an almost a six year rally within all major US markets**—expected as financial institutions seized advantage of nearly 0% interest rates established by the Fed. A substantial percentage of financial institutions borrowed this newly printed and virtually free capital with the intention of servicing and/or acquiring firms with the natural expectation of a positive return on investment.

Post the announcement and execution of QE under former Fed Chair, Ben Bernanke, during the latter half of 2008, many investors warned of equity markets and their possible over saturation of QE capital, which was a warranted concern after saturation fears turned to reality—albeit seemingly in waves of market duress. At the moment, the junk bond market has become a common indicator for identifying three of many market crises catalysts:

1. Firms typically must issue junk bonds for debt obligations, operations, etc., and the high yields earned with these investment vehicles offers a safer security for a large portion of investors. The concentration of large positions in high-yield, high-risk bonds would likely lead to above-average market and regulatory adjustments if equity investment becomes a less favorable option.

2. Since the implementation of QE, portfolio managers have allocated their portfolios with a greater percentage of junk bonds due to low capital borrowing costs resulting in outstanding returns. Unfortunately, most have forgotten that QE has been the driver of market performance over the past six to seven years, which is the reason for corporate and individual strategic shifts in market behavior in preparation for the rise in interest rates.

3. As aforementioned, in anticipation of a Fed rate hike, many bondholders are actively searching for higher yield elsewhere and simply do not find themselves comfortable facing exposure to an equity asset for which market forecasts have only grown bleaker—threatening long-term investors' portfolios due to their purposeful ignorance of equity market volatility. The purposeful ignorance of short-term volatility is a concept most long-term investors embrace, therefore driving investors to more stable securities hence severely devaluing equities.

*The Fed- The Federal Reserve **US markets- The New York Stock Exchange, S&P 500, and NASDAQ !2

Happening in Harbert: Fundraising

Dean Bill Hardgrave has announced an ambitious and visionary plan to raise $100 million for the College of Business. This campaign’s

momentum is attributed to the $40 million gift received by

Auburn alumnus, Raymond J. Harbert, during the summer of

2013 with subsequent donations equating to over $50 million

raised.

Budgeting outline

Students | $13 million

Programs | $54 million

Faculty | $32 million

Facilities | $1 million

For more information visit: develop.auburn.edu/ways/units/

business/

HARBERT HEADLINES MAY 6, 2015 RAYMOND J. HARBERT COLLEGE OF BUSINESS

Defining the current US market levels as too expensive for most investors' risk tolerances would be false, because the market is still appreciating on positive economic driven by firms with healthy financial statements. Much of the market is focused on the Technology sector, which has received some interesting valuations. These unmatched economic powerhouses (i.e., Amazon, Apple, Facebook, Google, etc.) would be the few firms with going concern based on stable and substantial revenue sources—some companies like Tesla that are yet to earn a profit has been valued to project future sales and innovations hence the discrepancy between Tesla's financial statements and market valuation. With such speculative offerings like Tesla, stable corporate powerhouses like Apple, and the classic blue-chip firms like GE, investors have countless alternative strategies to pursue in order to maintain adapted to the market environment should the described circumstances above become reality.

Yellen's announcement was, again, a warning call to primarily bondholders and the vast majority of anyone exposed to the impending credit cycle along with massive capital reallocation in the markets. Fortunately, a silver lining was revealed by the Fed Chair stating risks to the US economy are “moderated, not elevated” according to Reuters. So, despite the weight of Yellen’s comments and the markets’ negative reaction to them, much is being done to mitigate any possible crises as implied by Yellen’s statement, “We’re trying to communicate as clearly about our monetary policy so we don’t take markets by surprise”—reassuring words during unsure conditions.

*The Fed- The Federal Reserve **US markets- The New York Stock Exchange, S&P 500, and NASDAQ !3