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After their 2020 run-up, do convertibles make sense for 2021?

2020 was a crazy year for investors, and convertible securities had an especially wild ride. From the beginning of the sell-off  on Feb. 20 to their low…

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2020 was a crazy year for investors, and convertible securities had an especially wild ride. From the beginning of the sell-off  on Feb. 20 to their low point on March 23 of 2020, the ICE BofA US Convertibles Index had declined by roughly 26%.1 After that dramatic – and brief – sell-off, convertible returns rebounded sharply, and the index was actually up 15% by the end of April from the March low. 1 And performance has continued to improve since then – the ICE BofA US Convertibles Index climbed by more than 46% in 2020, from Jan. 1 through Dec. 31. That puts the asset class in rarified air, trailing only the return on the NASDAQ 100 Index among the major equity and fixed income indices.1

What’s driven convertibles’ performance?

Recall that convertible securities are corporate bonds that have the ability to be converted into a fixed number of shares of the issuer’s common stock. In large measure, convertibles’ 2020 gains were fueled by the strong returns posted by the underlying stocks of issuers in technology and health care.2 An additional boost has come from a number of recent convert issuers whose businesses were significantly impacted by the pandemic – travel-related companies like airlines, ride hailing and cruise ship companies, retailers and restaurants, to name some – and have had sharp gains in their stock and convertible prices since the spring.

Record-setting issuance

In addition to, and in part because of those gains, the convertible market in the US had record-setting new issuance in 2020. Over $113 billion in new paper came from what we would refer to as its core constituent participants – technology and health care companies – and also from those previously mentioned companies most impacted by the pandemic, which sought out balance-sheet-firming capital to ride out the current period of little-to-no revenue generation.3 Indeed, converts from consumer discretionary sector issuers – many in that significantly impacted category – had comprised just 8% of the US convertible universe at the end of 2019 but now make up 18%.2 Adding up the returns and the issuance, the size of the US convertible market has expanded from $212 billion at the end of 2019 to $325 billion as of the end of November 2020, growth of over 50%.2

More broadly, issuance in 2020 has also been the result of the low interest rate environment and high stock volatility. Those attributes have enabled convert issuers to raise money on very attractive terms, and many issuers are using proceeds to refinance previously existing higher-cost debt or pursue earnings-accretive acquisitions, among other things.2

Do converts still make sense?

Given the returns, the issuance and the attention the asset class has gotten in the financial media, it’s not surprising that our team has received a large number of inquiries about convertibles in general and Invesco Convertible Securities Fund in recent months. In addition to questions about what has driven the returns and record issuance in 2020, one other key topic we’re addressing is does it still make sense to invest in converts? We think the answer is yes and three reasons come immediately to mind:

  • First, the asymmetric return profile of converts may allow investors to participate more in the upside in their underlying stocks than in their downside due to the converts’ fixed income floor.
  • Second is the yield advantage that converts have had relative to their underlying stocks. According to data from Bank of America Merrill Lynch, that figure is currently around 90 basis points. And while that’s not a big number by historical standards, in an environment where 10-year Treasuries have been yielding less than 1%, it’s significant.
  • Third is converts’ historical outperformance during periods of rising interest rates. We’ve talked about this one for a long time, and while rates have continued lower, they will eventually start to rise. Compared to non-convertible fixed income, converts have outperformed during periods of rising rates given their equity component and their relatively short duration relative to both investment grade and high yield bonds.
Source: Invesco, Bloomberg L.P. Basis point is the smallest measure used for quoting yields on bonds and notes. One basis point is one one-hundredth of a percentage point, or 0.01%. If the US Federal Reserve increases its short-term interest rate target by 50 basis points, or a bond’s yield rises by 50 basis points, the change would be 0.50% or one-half of one percent. The S&P 500® Index is generally representative of the US stock market. The Barclays US Government Credit Index includes Treasuries and agencies that represent the government portion of the index, and it includes publicly issued US corporate and foreign debentures and secured notes that meet specified maturity, liquidity and quality requirements to represent the credit interests. The ICE BofAML US Convertible Index is an unmanaged index that measures performance of US dollar-denominated convertible securities not currently in bankruptcy with a total market value greater than $50 million at issuance. The S&P LSTA Leveraged Loan Index is designed to reflect the performance of the largest facilities in the leveraged loan market. Past performance cannot guarantee future results. Returns less than one year are cumulative; all other performance figures are annualized. Does not reflect or imply the performance of any Invesco fund. An investment cannot be made directly in an index.

To sum up, 2020 was a very good year for convertibles from both an issuance and a return perspective. That said, we continue to see positives ahead as we move into 2021.

1 Source: ICE Data Services

2 Source: Bank of America Merrill Lynch, November chartbook

3 Source: Barclays CB Insights

Important information

Blog header image: Bonninstudio/ Stocksy

The ICE BofAML US Convertible Index tracks the performance of US-dollar-denominated convertible securities that are not currently in bankruptcy and have total market values of more than $50 million at issuance.

The S&P 500® Index is an unmanaged index considered representative of the US stock market.

An investment cannot be made directly in an index.

Convertible securities may be affected by market interest rates, the risk of issuer default, the value of the underlying stock or the issuer’s right to buy back the convertible securities.

An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.

The risks of investing in securities of foreign issuers, including emerging markets, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Junk bonds involve a greater risk of default or price changes due to changes in the issuer’s credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.

Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.

Preferred securities may include provisions that permit the issuer to defer or omit distributions for a certain period of time, and reporting the distribution for tax purposes may be required, even though the income may not have been received. Further, preferred securities may lose substantial value due to the omission or deferment of dividend payments.

A decision as to whether, when and how to use options involves the exercise of skill and judgment and even a well-conceived option transaction may be unsuccessful because of market behavior or unexpected events. The prices of options can be highly volatile and the use of options can lower total returns.

The Fund is subject to certain other risks.  Please see the current prospectus for more information regarding the risks associated with an investment in the Fund.

The opinions referenced above are those of the author as of Dec. 29, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

Before investing, investors should carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the fund(s), investors should ask their financial professionals for a prospectus/summary prospectus or visit invesco.com.

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China Suggests It Could Maintain ‘Zero COVID’ Policy For 5 Years

China Suggests It Could Maintain ‘Zero COVID’ Policy For 5 Years

Authored by Paul Joseph Watson via Summit News,

China has suggested it will…

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China Suggests It Could Maintain 'Zero COVID' Policy For 5 Years

Authored by Paul Joseph Watson via Summit News,

China has suggested it will maintain its controversial ‘zero COVID’ policy for at least 5 years, eschewing natural immunity and guaranteeing repeated rounds of new lockdowns.

“In the next five years, Beijing will unremittingly grasp the normalization of epidemic prevention and control,” said a story published by Beijing Daily.

The article quoted Cai Qi, the Communist Party of China’s secretary in Beijing and a former mayor of the city, who said that ‘zero COVID’ approach would remain in place for 5 years.

After the story prompted alarm, reference to “five years” was removed from the piece and the hashtag related to it was censored by social media giant Weibo.

“Monday’s announcement and the subsequent amendment sparked anger and confusion among Beijing residents online,” reports the Guardian.

“Most commenters appeared unsurprised at the prospect of the system continuing for another half-decade, but few were supportive of the idea.”

Although western experts severely doubt official numbers coming out of China, Beijing claimed success in limiting COVID deaths by enforcing the policy throughout 2021.

However, this meant that China never achieved anything like herd immunity, and at one stage the Omicron variant caused more more coronavirus cases in Shanghai in four weeks than in the previous two years of the entire pandemic.

Back in May, World Health Organization Director General Tedros Adhanom Ghebreyesus suggested that China would be better off if it abandoned the policy, but Beijing refused to budge.

As we previously highlighted, the only way of enforcing a ‘zero COVID’ policy is via brutal authoritarianism.

In Shanghai, children were separated from their parents in quarantine facilities and others were left without urgent treatment like kidney dialysis.

Panic buying of food also became a common occurrence as the anger threatened to spill over into widespread civil unrest.

Former UK government COVID-19 advisor Neil Ferguson previously admitted that he thought “we couldn’t get away with” imposing Communist Chinese-style lockdowns in Europe because they were too draconian, and yet it happened anyway.

“It’s a communist one party state, we said. We couldn’t get away with it in Europe, we thought,” said Ferguson.

“And then Italy did it. And we realised we could,” he added.

*  *  *

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Tyler Durden Tue, 06/28/2022 - 18:05

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No sign of major crude oil price decline any time soon

Bullish pressure on crude oil markets doesn’t seem to be easing Crude oil prices fell last week, notching their second weekly decline in the face of…

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Bullish pressure on crude oil markets doesn’t seem to be easing

Crude oil prices fell last week, notching their second weekly decline in the face of concern that rising interest rates could push the global economy into recession.

Yet the future of crude oil still seems bullish to many. Spare capacity, or lack of it, is just one of the reasons.

The global surplus of crude production capacity in May was less than half the 2021 average, the U.S. Energy Information Administration (EIA) reported on Friday.

The EIA estimated that as of May, producers in nations not members of the Organization of Petroleum Exporting Countries (OPEC) had about 280,000 barrels per day (bpd) of surplus capacity, down sharply from 1.4 million bpd in 2021. It said 60 per cent of the May 2021 figure was from Russia, which is increasingly under sanctions related to its invasion of Ukraine.

The OPEC+ alliance of oil producers is running out of capacity to pump crude, and that includes its most significant member, Saudi Arabia, Nigerian Minister of State for Petroleum Resources Timipre Sylva told Bloomberg last week.

“Some people believe the prices to be a little bit on the high side and expect us to pump a little bit more, but at this moment there is really little additional capacity,” Sylva said in a briefing with reporters on Friday. “Even Saudi Arabia, Russia, of course, Russia, is out of the market now more or less.” Nigeria was also unable to fulfil its output obligations, added Sylva.

Recent COVID-19-related lockdowns in parts of China – the world’s largest crude importer – also played a significant role in the global oil dynamics. The lack of Chinese oil consumption due to the lockdowns helped keep the markets in a check – somewhat.

Oil prices haven’t peaked yet because Chinese demand has yet to return to normal, a United Arab Emirates official told a conference in Jordan early this month. “If we continue consuming, with the pace of consumption we have, we are nowhere near the peak because China is not back yet,” UAE Energy Minister Suhail Al-Mazrouei said. “China will come with more consumption.”

Al-Mazrouei warned that without more investment across the globe, OPEC and its allies can’t guarantee sufficient supplies of oil as demand fully recovers from the pandemic.

But the check on the Chinese crude consumption seems to be easing.

On Saturday, Beijing, a city of 21 million-plus people, announced that primary and secondary schools would resume in-person classes. And as life seemed to return to normal, the Universal Beijing Resort, which was closed for nearly two months, reopened on Saturday.

Chinese economic hub Shanghai, with a population of 28 million-plus people, also declared victory over COVID after reporting zero new local cases for the first time in two months.

The two major cities were among several places in China that implemented curbs to stop the spread of the omicron wave from March to May.

But the easing of sanctions should mean oil’s price trajectory will resume its upward march.

In the meantime, in the U.S., the Biden administration is eying tougher anti-smog requirements. According to Bloomberg, that could negatively impact drilling across parts of the Permian Basin, which straddles Texas and New Mexico and is the world’s biggest oil field.

While the world is looking for clues about what the loss of supply from Russia will mean, reports are pouring in that the ongoing political turmoil in Libya could plague its oil output throughout the year.

The return of blockades on oilfields and export terminals amid renewed political tension is depriving the market of some of Libya’s oil at a time of tight global supply, said Tsvetana Paraskova in a piece for Oilrpice.com.

And in the ongoing political push to strangle Russian energy output, the G7 was reportedly discussing a price cap on oil imports from Russia. Western countries are increasingly frustrated that their efforts to squeeze out Russian energy supplies from the markets have had the counterproductive effect of driving up the global crude price, which is leading to Russia earning more money for its war chest.

To tackle the issue, and increase pressure on Russia, U.S. Treasury Secretary Janet Yellen is proposing a price cap on Russian crude oil sales. The idea is to lift the sanction on insurance for Russian crude cargo for countries that accept buying Russian oil at an agreed maximum price. Her proposal is aimed at squeezing Russian crude out of the market as much as possible.

So the bullish pressure on crude oil markets doesn’t seem to be easing.

By Rashid Husain Syed

Toronto-based Rashid Husain Syed is a respected energy and political analyst. The Middle East is his area of focus. As well as writing for major local and global newspapers, Rashid is also a regular speaker at major international conferences. He has provided his perspective on global energy issues to the Department of Energy in Washington and the International Energy Agency in Paris.

Courtesy of Troy Media

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WTI Extends Gains After Unexpected Crude Draw

WTI Extends Gains After Unexpected Crude Draw

Oil prices are higher today following relatively positive news from China (easing some of its…

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WTI Extends Gains After Unexpected Crude Draw

Oil prices are higher today following relatively positive news from China (easing some of its COVID quarantine restrictions), Macron-inspired doubts over the ability of Saudi Arabia and the United Arab Emirates to significantly boost output, and unrest in Ecuador and Libya helped lift prices.

“We’re in the crunch period, it’s hard to see any meaningful price relief for crude,” said John Kilduff.

There’s a lot of strength with China relaxing its Covid restrictions and starting its independent refiners, “we’re going to have another chunk of demand for crude oil,” as China relaxes its Covid-19 restrictions.

With no EIA data released last week due to a "systems issue" (they have issued a statement confirming that the data - and the newest data - will both be released tomorrow), the only guidance we have for now on the past week's inventory changes is from API...

API (last week)

  • Crude +5.607mm

  • Cushing -390k

  • Gasoline +1.216mm - first build since March

  • Distillates -1.656mm

API (this week)

  • Crude -3.799mm

  • Cushing -650k

  • Gasoline +2.852mm

  • Distillates +2.613mm

Crude stocks unexpectedly fell last week, almost erasing the major build from the week before (according to API). Gasoline stocks rose for the second straight week

Source: Bloomberg

WTI was hovering around $111.75 and pushed up to $112 after the unexpected crude draw...

Finally, we note that the tight supply situation in oil (especially European) is revealing itself in the WTI-Brent spread, grew to $6.19, the widest in almost three months.

“European demand will remain robust, especially as natural gas supplies run out, while the North American demand for crude is weakening,” said Ed Moya, senior market analyst at Oanda.

This is not good news for President Biden as prices are rising...

And his ratings are hitting record lows.

Tyler Durden Tue, 06/28/2022 - 16:37

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