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Nicholas Leach, vice-president, CIBC Asset Management.
Looking back seven to eight months ago, towards the end of 2018, central banks turned from being hawkish to dovish, and market expectations for looser monetary policy increased, the bond markets rallied, and bond yields fell globally. We’re seeing all of these trends continue into the second half of 2019 as the markets digest mixed economic signals globally.
There’s two real main concerns that the central banks have. First is geopolitical uncertainty, which is having a negative impact on business, especially in Europe, and on investor confidence. This is mainly driven by the global trade war headlines and Brexit and things like that. The second concern is low inflation. Now it’s very difficult to predict the outcome or the impact of geopolitical uncertainty other than to say that these risks are usually sort of short term in nature and they are currently elevated. So if there is an improvement, we should see an improvement in corporate spreads tightening.
And then when we look at inflation, which is the second concern the central banks have, I believe that technology is keeping a lid on global inflation for the long term. And it’s not just the Amazon and eBay effect; there’s smartphone penetration, which is over 100% in some cases. So every consumer is walking around with what is essentially a mobile price-discovery device, and this has really empowered them as a shopper and as a consumer. It’s not going to stop there. You have social media and things like YouTube where there’s a YouTube video that teaches everyone how to fix anything, anywhere, anytime. And if you can’t fix it, then you can go on to Craigslist or Kijiji and buy it second hand.
So looking forward, I think this momentum with technology is only going to improve. In the future we’re going to be introduced to 5G wireless, internet of things, artificial intelligence, smart cities, autonomous driving. And all of this should continue to contribute to lower costs. As long as inflation remains low, central banks have at least one reason to keep their interest rates low, and that should continue to push investors into the higher yielding corporate credits.
One of the largest holdings that we have in our high-yield funds is Sprint Communications. This is the fourth-largest wireless provider in the U.S. and it recently received Department of Justice approval and FCC approval to merge with T-Mobile, which is the third-largest wireless provider in the U.S. Sprint bonds offer great value. The credit spreads on the five-year Sprint bonds are around 400 basis points. And, when you look at T-Mobile, T-Mobile’s closer to 160. So there’s a big divergence there and we think that those credit spreads should converge as the merger proceeds. But even if it doesn’t proceed for one reason or another, we think that on a standalone basis the credit spreads on the Sprint bonds are just too wide. This company has $34 billion in revenues, $10 billion in operating cash flow, a $27-billion equity market cushion. And if you compare it to some of the Canadian wireless subscribers, Sprint’s subscriber base is almost twice the size of Rogers and Telus and Bell all combined. And Sprint has a similar balance sheet and leverage profile as the Canadian providers. So at a 400-basis point spread or a 5.5% yield, we think they’re really undervalued.
Then another important overweight for us is First Quantum. This company is the leading global producer of copper and it has recently spent several billions of dollars in developing the new copper mine in Panama. Now this mine will be one of the largest and lowest-cost in the world, and it’s soon to enter commercial production at the end of this year. So this is definitely going to have a positive material impact on their revenues, on their cash flows. It’s going to have a significant improvement in the company’s leverage profile as well as its diversification, and so these bonds are very, very attractive. The five-year bonds are a 9% yield, and they come with significant asset coverage with a $7 billion equity market cap cushion.