22 May 2013 by Jim Fickett.

The current volume of US corporate debt rated CCC is on the same scale as the volume of subprime mortgages before the last crisis.

The Financial Times quotes SIFMA to say that outstanding corporate debt in the US has grown from $5.5 trillion in 2007 to $9.1 trillion in 2012. Just the speed of that growth is interesting, and worrying, as a rush to lend usually indicates some lack of attention to creditworthiness.

It is particularly concerning that the fastest growth has been in lower credit ratings. As of 2011, 19% of the market was rated CCC (High-yield investors could get burned soon). Assuming that percentage was still approximately correct in 2012, that says the total amount of CCC-rated corporate debt as of last year was about $1.7 trillion. A CCC rating means the debt is very likely to default, even under current conditions.

“Subprime” was never a precisely defined term, and full data was hard to come by, so there are rather different estimates of the volume of subprime mortgages in 2007. An NBC article from March 2007 estimates $1.3 trillion. Edward Pinto, former chief credit officer for Fannie Mae and now a fellow at the American Enterprise Institute, estimates $2.5 trillion.

What is clear is that the volume of CCC corporate debt currently is in the same ballpark as the volume of subprime mortgages before the last crisis, and still growing rapidly.

Of course subprime was not the whole story in 2007. A similar amount of Alt-A mortgages were almost as bad as the subprime. But similarly, CCC is certainly not the whole story now. A much larger fraction of junk bonds than just the lowest rung is at risk.

Further, bank loans to companies are also growing rapidly, and many of these are probably poor quality. The Financial Times notes that C&I (Commercial and Industrial) loans at US banks grew 20% from Q1 of 2012 to Q1 of 2013. The total is still relatively small compared to the bond market, at $1.5 trillion. But these loans are mostly floating rate, so any normalization of interest rates could cause defaults to start rising, which in turn could shake confidence in the bond markets.

Moody's was recently quoted as saying,

What we’re concerned about is what’s being put on today [in C&I]. Based on what we’re seeing, this kind of lending could lead to the next asset bubble or crisis down the road.

I do not know, and no one knows, whether the US corporate bond market will precipitate a crisis. But it is quite clear that there is a very large amount of debt here that will never be repaid. Trouble brewing.

21 May 2013 by Jim Fickett.

Headline inflation is only running at 1.1%, but that is because of a temporary dip in energy prices. Core inflation, which better indicates the trend, is running at 1.7%, near the fairly universal central bank target of 2%. The biggest single driver of inflation, the cost of housing, has been going up at an annual rate of about 2% for over a year. Central bankers take “inflation expectations” seriously but, in fact, they are meaningless.

Here are headline and core inflation:

Here is the price level data for housing:

My position on the future of inflation is that there is significant danger. I am not predicting high inflation; in fact I don't think anyone can predict inflation. But highly unconventional monetary policy, combined with a dysfunctional congress and high projected deficits in the long term should certainly make one cautious. The Fed often takes the position that because inflation expectations, measured as the difference between nominal and inflation-linked bonds, are low, there is little danger. In fact, this measure is meaningless. Some time back I posted the following graph (Real bond yields), which shows that nominal bond yields correlate closely with current inflation, but do not anticipate future inflation:

Today John Plender at the Financial Times noted that the inflation-linked bond market shows, in fact, considerable fear about inflation, since people are willing to accept negative yields in order to acquire inflation protection:

Yields on fixed interest bonds are still astonishingly low by historic standards and, despite the protestations of central bankers, this is not because inflation expectations are well anchored because of their magnificent management of their currencies. Negative yields across much of the index-linked market tell us that people are desperate for insurance against resurgent inflation.

20 May 2013 by Jim Fickett.

Not all generics are quite what they seem, and it is worth learning something about the reputation of the company before accepting a product at the drugstore. That is the practical takeaway from a fascinating case history on Ranbaxy, a large Indian generics manufacturer, in a recent long article in Fortune.

Attempts to control healthcare costs have resulted in booming business for generics companies (84% of the US drug supply) and overseas factories (80% of all active pharmaceutical ingredients dispensed in the US).

Although 80% of drug manufacturing is overseas, little regulatory oversight is directed to overseas plants:

A report by the Government Accountability Office found that in 2009, regulators inspected only 11% of foreign drug manufacturing plants, while they inspected 40% of domestic ones.

The FDA has increased its inspections of foreign plants in recent years with a goal of reaching parity with the frequency of domestic inspections. It now has agents based in India and other countries. But even if the frequency were equal, the inspections themselves are not. Due to complex logistics, foreign inspections can last less than a week and allow companies weeks of advance notice, while domestic ones can last up to six weeks and are unannounced. “The reality is that we simply don't know what we're dealing with,” says Dr. Roger Bate, an international pharmaceutical expert. “No one has actually gone into these sites to expose what's going on.”

Fortune goes into considerable detail for one case where more regulation was/is clearly needed. It would seem that at Ranbaxy wholesale fabrication of results, fraudulent regulatory filings, and substandard products were all standard operating procedure:

Lying to regulators and backdating and forgery were commonplace, [Thakur, a whistelblower] says. The company even forged its own standard operating procedures, which FDA inspectors rely on to assess whether a company is following its own policies. Thakur's team was told of one instance in which company officials forged and backdated a standard operating procedure related to how patient data are stored, then aged the document in a “steam room” overnight to fool regulators.

Company scientists told Thakur's staff that they were directed to substitute cheaper, lower-quality ingredients in place of better ingredients, to manipulate test parameters to accommodate higher impurities, and even to substitute brand-name drugs in lieu of their own generics in bioequivalence tests to produce better results. …

[According to an internal report based on data from the whistleblower] “the majority of products filed in Brazil, Mexico, Middle East, Russia, Romania, Myanmar, Thailand, Vietnam, Malaysia, African Nations, have data submitted which did not exist or data from different products and from different countries …” The company not only invented data but also fraudulently mixed and matched data, taking the best results from manufacturing in one market and presenting it to regulators elsewhere as data unique to the drugs in their markets. …

In September 2008, [the US FDA] announced it was restricting the import of 30 drug products made by Ranbaxy (11 of which had been approved after Thakur's first contact with the FDA three years earlier) … finding that Ranbaxy had committed fraud on a massive scale.

Those at the FDA and within Ranbaxy who know the facts are reluctant to use the company's drugs.

congressional … investigators interviewed the FDA inspectors who went to Paonta Sahib and asked them a simple question: Would they feel comfortable taking Ranbaxy drugs? “Every single inspector that went to India said they would never take a Ranbaxy drug,” says Nelson, “like eight out of eight.”

They were not alone. One by one, each of the former Ranbaxy executives Fortune interviewed had determined, while still at the company, to stop taking Ranbaxy drugs.”

17 May 2013 by Jim Fickett.

There are a number of US natural gas liquefaction and export facilities planned and awaiting approval (North American LNG exports will make a significant difference in a few years). Today the Freeport, Texas project was approved. That is in addition to one other facility already approved, at Sabine Pass, LA.

How much difference do approvals so far make to the gas market?

Sabine Pass will begin exporting in 2016, and Freeport in 2017. Together they will export 3% to 4% of US production. So there will be no effect for 3-4 more years, and even then a relatively small portion of the market. Still, this is one more positive for the long-term prospects of natural gas.

16 May 2013 by Jim Fickett.

Today the Cabinet Office in Japan released its first estimate for real GDP in Q1. The one-quarter change was better than expected, causing some to celebrate the positive effects of Abenomics. However the quarterly changes are very noisy, and it would be surprising to see the new policies having any large effect so soon. The year-over-year change is a better indicator of the trend, and this shows no detectable growth at all.

(See the Reference page Japan GDP for background, sources, and past commentary.)

15 May 2013 by Jim Fickett.

Today Eurostat gave a first estimate for GDP in Q1. There are two main things to notice about the trend. First, this recession is showing a much milder drop, overall, than the great recession. Second, it has now gone on for six quarters, and shows no sign yet of easing.

(See the Reference page EU output for background, sources, and past commentary.)

15 May 2013 by Jim Fickett.

The latest month-to-month change in US industrial production was a decrease, which resulted in some negative headlines. But ignoring the tiny, noisy, monthly changes, the trend is still one of fairly normal growth, only slightly below the longer-term average.

I do think the stagnation in emerging markets and the recession in Europe are likely to hit the US eventually. But so far all signs of possible slowdown in the US are isolated and ambiguous.