Convertibles mostly flat for week; some see mixed performance for month, but indices gain

By Rebecca Melvin

New York, Aug. 31 - Despite news provided by several economic reports and the closely watched Jackson Hole speech Friday, the convertible bond market was quiet and flattish to mark month end, wrapping up a week that was quiet and flattish ahead of the Labor Day holiday weekend, market sources said.

Federal Reserve chairman Ben Bernanke "didn't rule anything out" at the annual symposium of the Federal Reserve in Jackson Hole, Wyo., saying that the Fed will provide additional policy accommodation "as needed" to promote economic recovery and improve labor market conditions.

"If he ruled something out, then everything changes; but he didn't," a New York-based convertibles trader said.

The broader markets moved modestly higher after the speech, but not with much conviction.

Amgen Inc. was a top volume name in convertibles, but there was little else of note during the session, sources said.

For the week, the convertibles of Gilead Sciences Inc. came in about 0.25 point on a dollar-neutral, or hedged, basis as the underlying shares of the Foster City, Calif.-based biopharmaceutical company traded in a narrow range for much of the week, a New York-based trader said.

Priceline.com Inc. added about 0.25 point on swap as underlying shares for the Norwalk. Conn.-based online travel company lifted from midweek onward amid no particular news.

Molycorp Inc.'s 6% convertibles opened up several points on a dollar-neutral, or hedged, basis after positive news for the Greenwood Village, Colo.-based rare earth minerals producer.

Ciena Corp.'s 0.25% convertibles and 4% convertibles looked to have improved 0.5 point on a hedged basis after disappointing earnings sent the underlying shares of the Linthicum, Md.-based optical networking gear maker sharply lower on Thursday.

Navistar International Corp. convertibles were flattish as the underlying shares of the Lisle, Ill.-based truck and engine maker lifted.

"The [Navistar] stock is higher, but the bonds have not rallied; they are not moving up, and have been divorced from the stock for a couple of weeks," a New York-based trader said.

A second trader said convertibles for the week were "more or less flat" and "risk was mediocre."

He noted that coal names continued to do better and the Omnicare Inc. exchangeable was active and higher by 0.125 point during the week.

Mixed performance in August

For the month, convertible bonds modestly outperformed, although there was a "mixed" aspect to the universe, in general, sources said.

"I thought it was a mixed bag, and nothing special in either direction," a trader said of August's market.

He noted that there were names that "came in" like Central European Distribution Corp., which is close to maturity yet slipped down to 92.

"Navistar definitely got better vis a vis the common, and the WMGI [Wright Medical Group Inc.] deal worked out very well," he said.

He noted that many of the shorter-dated issues of strong credits did better like Alliant Techsystems Inc.'s 3% notes, but "BPZ Resources Inc. came in 5 or 6 points in the last few days on nothing; they just got weaker."

But according to Barclays' U.S. convertible composite index, outrights gained 1.94% for the month, excluding Friday's performance. As for hedged players, the Hedge Fund Research convertible arbitrage index showed a 0.4% increase for the month.

Valuations tight year to date

For the year so far, valuations have been getting tighter and helping investors make return, but it has largely come at the expense of new issuance, which has been in the doldrums.

"We didn't have issuance, so a lot of people are getting tighter, and over the year, they've done better," a trader said.

But on the other hand, unless something changes, there is not much hope for improvement looking ahead unless there are sharp stock moves either up or down, a trader said.

"There's not much to make in convertibles at this point," he said. "If you're up 4% to 5%, you'd like to gain more. But I don't see how any of this stuff is eligible to improve in the future unless shares move."

For longer duration, hedge names, stocks need to move hard and far in either direction, the trader said.

At this point, the HFR convertible arbitrage index is up 5.6% for the year to date. But that could start to leak with action in the stock market, he said.

"If you don't see sharp moves, they'll probably start giving back," he said.

Another factor, of course, is if there is an improvement in the pace of new issuance, which has been pretty anemic for the year to date, but which improved in August.

Total volume for the first eight months of 2012 is slightly more than half of the pace for issuance in the same period of 2011, with $12.93 billion of new issuance in 46 deals, compared to $22.77 billion in 72 deals for the same period of 2011, according to Prospect News' data.

For August alone, U.S. issuance picked up significantly from the practically moribund issuance market in July. For August, there were seven U.S. deals (compared to two deals in July) for $1.71 billion, compared to $201 million of new issuance for July alone.

August's notable new deal was Wright Medical Group Inc.'s upsized 2% convertibles senior notes due 2017. That deal did well, and the stock has moved up well since the date of issue, traders noted.

Bernanke comments

Bernanke said that after nearly four years of large-scale asset purchases, empirical data has emerged, reflecting the benefits that the policies have had. The large-scale purchases have lowered long-term Treasury yields and that has led to more economic output.

But the downside of further Fed "nontraditional" action is that it could impair the functioning of securities markets and reduce public confidence in the Fed's ability to exit smoothly from its accommodative policy at the appropriate time.

It "could induce an imprudent reach for yield by some investors and thereby threaten financial stability," Bernanke told his audience at Jackson Hole. In addition, the Fed "could incur financial losses should interest rates rise to an unexpected extent."

For all these reasons, "the hurdle for using nontraditional policies should be higher than for traditional policies, he said. "At the same time, the costs of nontraditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant," he said.

The bottom line is that he said that there is a readiness to do more in terms of the central bank's easy money policies, but no actions should be expected ahead of the September policy meeting.

Meanwhile, the University of Michigan-Thomson Reuters' reading of consumer confidence in August rose to 74.3, which was better than the initial 73.6 estimate and better than 72.3 in July.

The sentiment survey was more hopeful than the Conference Board's consumer-confidence index released earlier this week, which showed a deterioration of confidence in August to 60.6 from 65.4.

Also on Friday, the Commerce Department reported that U.S. factory orders rose 2.8% in July, which was better than the 2% rise expected. And a survey of manufacturers in the Chicago region showed that activity decelerated slightly to a reading of 53.0 in August from 53.7 in July, but which was in line with expectations.

Mentioned in this article:

Amgen Inc. Nasdaq: AMGN

Ciena Corp. Nasdaq: CIEN

Molycorp Inc. NYSE: MCP

Navistar International Corp. NYSE: NAV

Omnicare Inc. NYSE: OCR

Priceline.com Inc. Nasdaq: PCLN

Wright Medical Group Inc. Nasdaq: WMGI

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