Lookout Report from Global Markets Intelligence

The Federal Reserve Will Be Taking Cues From What Should Finally Be An Unbridled Yield Curve In 2016

Michael G Thompson The upcoming final Federal Open Market Committee (FOMC) meeting of 2015 (Dec. 15 and Managing Director Global Markets Intelligence 16) will give Federal Reserve Chair Janet Yellen one last chance to make good on her statement (1) 212-438-3480 made on July 10: "I expect that it will be appropriate at some point later this year to take the [email protected] first step to raise the federal funds rate and thus begin normalizing monetary policy." Regardless Robert A Keiser Vice President of the result of the Fed's upcoming meeting, Global Markets Intelligence (GMI) is much more Global Markets Intelligence concerned with the direction of U.S. interest rates in 2016. To this end, we continue to believe (1) 212-438-3540 [email protected] that the FOMC needs to commence the normalization of U.S. monetary policy, effectively disconnecting the bond market "from the tethers of Fed indecision."

We believe that the Fed has exerted an enormous influence on bond market yields since it first began buying U.S. mortgage-backed and government securities to shore up the financial system during the darkest moments of the financial crisis in late 2008. Through prolonged security purchases, the Fed expanded the U.S. monetary base to $4 trillion today from $850 billion at

The Lookout Report is a compendium the start of September 2008. And even after the Fed ceased open market security purchases by of current data and perspectives from the end of 2014, it continued to keep a lid on U.S. bond yields via the multi-year extension of across S&P Capital IQ and S&P Dow Jones Indices covering corporate the accommodative zero interest rate policy. Even now, the extremely cautious nature of most earnings, market and credit risks, FOMC voting members has reinforced global investors' longstanding lack of fear of the Fed, capital markets activity, index which has helped flatten the U.S. Treasury yield curve since mid-year 2015 despite the investing, and proprietary data and analytics. Published biweekly by the increasing likelihood of a preliminary rate hike at the next meeting. Global Markets Intelligence research group, the Lookout Report offers a As first cited in our market commentary before the September FOMC meeting (see "Lookout detailed cross-market and cross-asset view of investment conditions, risks, Report: The Fed Needs To Unbridle The Yield Curve," published Sept. 4, 2015), the yield and opportunities. spread between the 10-year and two-year Treasury notes continues to hold within the 2015 range established earlier this year between the low of 119 basis points (bps) set on Feb. 2 and the year's high of 177 bps recorded on June 26 and July 10. Since mid-year, this yield curve has flattened by 47 bps to 124 bps from 171 bps. We reiterate our position that should this yield spread begin to narrow below 120 bps, there will be little reason for the Fed to quickly follow up on the initial policy normalization adjustment to the overnight Fed funds target rate. Alternatively, a curve steepening above the 147.5 bps mid-point of the current range could suggest the need for a timely follow-up adjustment of monetary policy. Any sustained steepening above the 2015 high watermark of 177 bps could hint that investors feel that the Fed is behind

December 4, 2015

32871550 | 270752268 The Federal Reserve Will Be Taking Cues From What Should Finally Be An Unbridled Yield Curve In 2016 Lookout Report from Global Markets Intelligence the curve and in need of a more aggressive normalization timetable (see chart 1).

Chart 1

To be fair, the Fed's zero interest rate policy and the prior multiple rounds of quantitative easing are not solely responsible for the longstanding level of suppressed and historically low fixed income market yields. The U.S. economy continues to send mixed signals ranging from the robust readings of the Institute for Supply Management services Purchasing Managers' Index (PMI) indicator contrasted with the manufacturing PMI that fell to 48.6 in November, which is the weakest level seen since June 2009 and suggests that the manufacturing-centric portion of the U.S. economy is at risk of recession (see chart 2). Furthermore, how should Fed officials and investors alike reconcile the wide discrepancies recently witnessed among the strongest readings on automobile sales and mortgage applications to purchase homes seen to date during the recovery versus consumer confidence that just fell to the lowest level recorded since September 2014? We believe that these wide and somewhat confusing divergences will work themselves out over time, in line with the steady but still historically subpar experience that characterizes the post-financial crisis growth cycle.

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Chart 2

We agree with the majority of market participants and many FOMC members that the time has finally come for the Fed to stop talking about normalizing monetary policy and to actually do it. After discussing the liftoff of Fed tightening for the past two years, any further delay could begin to tarnish Fed credibility. The multiple crosscurrents within the U.S. economy aside, the accumulation of economic data this year suggests that it has now become difficult to justify the continuation of emergency monetary stimulus. A single 25 bp rate hike will be meaningless to the $16.4 trillion GDP U.S. economy that has grown by an average of 2.2% since exiting the recession in the third quarter of 2009, as opposed to the average 3.25% GDP growth that occurred in the 67 years preceding the great recession. In the coming year, GMI believes that the sustained trajectory of job creation, wage growth, and the resulting rate of core inflation will dynamically influence the slope of the Treasury yield curve. In turn, this will send important signals to both the FOMC and investors about the prospect of subsequent adjustments to U.S. and perhaps even global monetary policy in the years to come.

Inside This Issue:

Macroeconomic Overview: The Federal Reserve Will Be Taking Cues From What Should Finally Be An Unbridled Yield Curve In 2016 The upcoming final FOMC meeting of 2015 (Dec. 15 and 16) will give Federal Reserve Chair Janet Yellen one last chance to make good on her statement made on July 10 to start normalizing monetary policy before the end of the year. Regardless of the result of the Fed's upcoming meeting, GMI is much more concerned with the direction of U.S. interest rates in 2016. To this end, we continue to believe that the FOMC needs to commence the normalization of U.S. monetary

December 4, 2015 3 32871550 | 270752268 The Federal Reserve Will Be Taking Cues From What Should Finally Be An Unbridled Yield Curve In 2016 Lookout Report from Global Markets Intelligence policy, effectively disconnecting the bond market "from the tethers of Fed indecision."

Economic And Market Outlook: Third-Quarter Closes Out; 2016 Feels Like Déjà vu Third-quarter earnings season is basically complete with only H&R Block Inc., Hudson City Bancorp Inc., and Joy Global Inc. left to report. EPS stand at $29.63, representing a decline in growth of 1.4%, the first decline in earnings since the third quarter of 2009. On Dec. 3, the ECB announced it would extend its bond purchasing program through March 2017 (previously expected to expire in September 2016). The ECB also cut its deposit rate to -0.3% from -0.2% and left the main refinancing rate unchanged. Most investors expected this move, though some were hoping that expectations would have been exceeded.

Leveraged Commentary And Data: Leveraged Loans Lose 0.88% In November; Year-Do-Date Return Is 0.37% The S&P/LSTA Index lost 0.88% in November amid weak technical conditions. It was the Index's worst month since it fell 1.25% in December 2014, and it amplified the 0.18% loss in October. The S&P/LSTA Index has posted losses for six consecutive months, matching the period from July through December 2008 for the longest losing streak on record. Of course, the magnitude of the recent decline, at 2.80%, pales beside that of the second half of 2008, when the index collapsed a record 28.32% during the worst capital markets carnage since the Great Depression.

R2P Corporate Bond Monitor In the month when U.S. GDP growth was revised upward to 2.1% (previously at 1.5%; the second quarter was 3.9%), more recent data illustrated mixed economic improvement as the clamor for rate rises in December's FOMC meeting was sustained. Domestically, strength in the labor markets continued and still supported spending as retail sales remained positive in October with a 0.1% rise, similar to the prior month. In the eurozone, heightened geopolitical and extraneous events have taken center stage, but economically, the situation appeared largely stable in November, according to the balance of data, despite PMI figures continuing to show strength.

Capital Market Commentary: IPOs, M&A, And Debt Underwriting activity for IPOs retreated in November in both number of new issues and proceeds raised. According to S&P Capital IQ data, 11 IPOs came to market last month and raised $1.24 billion. In contrast, October saw 17 IPOs completed on major U.S. exchanges with total proceeds of $5.32 billion. On the M&A front, big deals dominated November M&A activity. According to S&P Capital IQ data, 26 deals worth $1 billion or greater were announced. That matched October's count for deals of that size and stands only behind July (34 deals) for deals of $1 billion or greater taking place this year.

Economic And Market Outlook: Third-Quarter Closes Out; 2016 Feels Like Déjà vu

North America Third-quarter earnings season is basically complete with only H&R Block Inc., Hudson City Bancorp Inc., and Joy Global Inc. left to report. Earnings per share (EPS) stand at $29.63, representing a decline in growth of 1.4%, the first decline in earnings since the third quarter of 2009. Excluding the 58.6% decline in energy earnings, growth is a more respectable 6.2%, though it's still below the historical average quarterly growth rate of 8.0%. The index has a 65% beat rate, which is below the historic beat rate of 66% for the first time since the fourth quarter of 2013.

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Chart 3

Assessing the full year, the current S&P Capital IQ earnings estimate for 2015 is $117.10, representing a 0.7% decline year over year and the first annual earnings decline since 2009. Early 2015 expectations looked for earnings to expand by 7%, but as the year progressed, quarterly earnings growth deteriorated with each passing quarter. This resulted in lower reported growth rates in each sequential quarter. The fourth quarter is now expected to mark the bottom for EPS growth with a decline of 4.5%.

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Chart 4

Despite the major economic headwinds endured during the first quarter of 2015--a surging U.S. dollar, declining oil prices, unseasonable weather, weak economic growth, and a West Coast port closure--the quarter actually had the strongest EPS growth of the year. Health care was the clear leader among the sectors with 21% growth, followed by financials and technology, both of which are typically considered cyclical in nature. This normally might have hinted at a potential rebound in S&P 500 earnings growth over the balance of 2015 as the cyclical sectors often lead EPS growth in an improving economic environment. However, macroeconomic headwinds failed to subside as overall economic data remained spotty, the dollar stood strong, and crude oil prices stayed under pressure as the year progressed. Furthermore, 2015 earnings growth had to endure tough quarterly EPS growth comparisons from 2014 (see chart 5).

A positive development over the year, though, was that the consumer discretionary and telecommunication services sectors joined health care as EPS growth leaders in the second and third quarters and are expected to be bright spots in the fourth quarter. All three sectors are largely domestic in nature, and as such are insulated from currency and commodity woes that are weighing on other sectors, such as energy, industrials, and materials. Furthermore, these three sectors are expected to close out 2015 with double-digit earnings growth and are the only sectors displaying growth of this magnitude.

Since the start of 2015, the top three leading and lagging sectors, including their respective EPS growth rates, have changed dramatically relative to original expectations. The two largest changes involved the materials and telecommunications sectors. The materials sector has not been a top performer as was initially expected. It actually has the second-worst growth rate (at -6.4%) of the 2015 S&P 500 Index. And telecommunications is now among the sector

December 4, 2015 6 32871550 | 270752268 The Federal Reserve Will Be Taking Cues From What Should Finally Be An Unbridled Yield Curve In 2016 Lookout Report from Global Markets Intelligence leaders with double-digit growth instead of the low single-digit growth originally anticipated. The former has been hit hard by commodity price declines, and the latter sector is benefiting from an improvement in industry operating conditions.

One trend that is playing out is the strength of the consumer discretionary sector. Although it is no longer the top sector as was initially expected with a growth rate of 16.9%, it is still projected to have the second-best growth rate at 10.9% and is the only sector from the original top three that is still leading. Financials was originally expected to generate the second-strongest growth at 15.7% but has now slipped to fourth place with 7.9% growth. Materials was expected to have the third-strongest growth on Jan. 1 but is now in the second to last spot.

Energy was always expected to post a decline in earnings, though the magnitude has more than doubled to -58.1% from -27.3% expected early in the year. Utilities and telecommunications were expected to join energy at the bottom of the list in terms of growth, but as discussed previously, telecommunications is now near the top of the growth list. Utilities, though still only projecting growth of 1.5% (versus 2.3% initially), moved up to seventh place (from eighth).

Table 1 2015 Sector Earnings Per Share Growth Estimates --2015 earnings per share growth (%)--

Sector As of Jan. 1, 2015 As of Dec. 3, 2015 Change (basis points) Consumer discretionary 16.92 10.86 (606) Consumer staples 6.21 0.02 (618) Energy (27.27) (58.12) (3,085) Financials 15.67 7.86 (781) Health care 10.98 14.04 306 Industrials 9.51 3.56 (595) Information technology 11.12 3.31 (781) Materials 13.74 (6.37) (2,011) Telecommunication services 4.97 11.27 630 Utilties 2.29 1.46 (83) S&P 500 6.97 (0.72) (770)

Source: S&P Capital IQ.

Looking forward to 2016, growth is expected to rebound to 8% on EPS of $126.42. That's quite close to the initial 7% growth expectation for 2015. What's more, the consumer discretionary, materials, and financials sectors are expected to drive growth in 2016, just as they were expected to lead 2015. The current thinking is that consumer spending will remain robust in the year ahead as it drives economic growth and benefits the discretionary sector; a rising interest rate environment will benefit financials; and materials will rebound from a low base as commodities first stabilize and potentially recover amid a generally improving global economic environment.

For more on the 2016 set-up, factors that affected 2015, and how annual estimates at the start of the year historically size up to the actual results, see the detailed report: "2016 Looks like The 2015 Set-Up That Never Played Out…" on the S&P Capital IQ platform.

Europe On Dec. 3, the European Central Bank (ECB) announced it would extend its bond purchasing program through March 2017 (previously expected to expire in September 2016). The ECB also cut its deposit rate to -0.3% from -0.2% and left

December 4, 2015 7 32871550 | 270752268 The Federal Reserve Will Be Taking Cues From What Should Finally Be An Unbridled Yield Curve In 2016 Lookout Report from Global Markets Intelligence the main refinancing rate unchanged. Most investors expected this move, though some were hoping that expectations would have been exceeded.

Earnings growth rates for the Euro 350 continue to see some deterioration from month-ago levels, though overall they remain strong, especially when compared with the anemic growth of -0.7% expected in the U.S. for 2015. Earnings growth is currently pegged at 8.2% (versus 8.1% a month ago) for 2015 and it is expected to be 7.0% in 2016 (versus 8.0% a month ago).

Eight of 10 sectors are expected to report growth this year with seven of eight projecting double-digit figures. Technology (25.4%), financials (21.1%), consumer discretionary (17.4%), telecommunications (15.7%), and health care (13.3%) lead with robust growth rates. Industrials, utilities, and consumer staples round out the index with growth of 13.1%, 12.8%, and 6.3%, respectively. Energy (-35.1%) and materials (-15.9%) are the only sectors with projected declines.

Table 2 Euro 350 Calendar-Year 2015 And 2016 EPS And Growth Rate --Calendar-year 2015-- --Calendar-year 2016--

Sector EPS (€) Growth (%) EPS (€) Growth (%) Consumer discretionary 120.20 17.4 137.26 14.2 Consumer staples 154.01 6.3 166.35 8.0 Energy 78.34 (35.1) 81.71 4.3 Financials 73.89 21.1 77.30 4.6 Health care 127.62 13.3 137.27 7.6 Industrials 104.56 13.1 112.70 7.8 Information technology 61.26 25.4 71.54 16.8 Materials 117.33 (15.9) 128.96 9.9 Telecommunication services 74.47 15.7 78.75 5.7 Utilities 96.65 12.8 93.11 (3.7) S&P 350 95.57 8.2 102.26 7.0

EPS--Earnings per share. Source: S&P Capital IQ.

Contact Information: Lindsey Bell, Senior Analyst--Global Markets Intelligence, [email protected].

Leveraged Commentary And Data: Leveraged Loans Lose 0.88% In November; Year-Do-Date Return Is 0.37%

The S&P/LSTA Index lost 0.88% in November amid weak technical conditions. It was the Index's worst month since it fell 1.25% in December 2014, and it amplified the 0.18% loss in October. The largest loans that constitute the S&P/LSTA Loan 100 closely tracked the broader Index in November, falling 1.05%, after outperforming with a skinny 0.01% gain in October.

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Chart 5

The S&P/LSTA Index has posted losses for six consecutive months, matching the period from July through December 2008 for the longest losing streak on record. Of course, the magnitude of the recent decline, at 2.80%, pales beside that of the second half of 2008, when the index collapsed a record 28.32% during the worst capital markets carnage since the Great Depression. To put the performance of the past six month in context, it is the fourth-worst half-year performance for the index on record.

Table 3 Largest Six-Month Index Losses

Total return (%) Market value return (%) July 2008-December 2008 (28.32) (30.98) March 2011-August 2011 (4.11) (6.34) May 2012-October 2002 (3.19) (5.35) June 2015-November 2015 (2.80) (5.11) June 2007-November 2007 (1.45) (5.31)

Source: S&P Capital IQ LCD.

Through November, the S&P/LSTA Index is up a slim 0.37% in the year to date. Nobody knows what December will bring, but if the year were to end now, the return in 2015 would outpace only 2008's 29.10% loss, the only annual loss in the index's near 19-year history. The S&P/LSTA Loan 100, meanwhile, enters December in negative territory, declining

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1.55% in the year to date.

Chart 6

The secondary continued to trade off in November. The average price of the S&P/LSTA Index fell to a near four-year low of 92.63 from 93.68 at the end of October and the 2015 high-water mark of 97.59 from April. Likewise, performing loans, which do not include Energy Future Holdings Corp., fell to a four-year low of 94.08 from 95.14 at the end of October and a year-to-date peak of 98.56 on April 24.

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Chart 7

With the bears in control, better-rated loans again outperformed in November, widening their lead so far this year. Likewise, second-lien loan returns lagged those of first-lien loans, falling further behind in the year to date. The rout in defaulted loans is largely a result of this year's precipitous decline in the Energy Future Holdings legacy loan, which has also dragged on overall loan returns. Excluding Energy Future Holdings, defaulted loan returns are far less ugly at -19.07% so far this year.

Table 4 Returns By Type Of Debt

October 2015 (%) November 2015 (%) Year to date (%) Average bid All loans (0.18) (0.88) 0.37 92.63 Performing loans (0.06) (0.95) 1.16 94.08 BB 0.05 (0.56) 2.68 97.01 B (0.13) (1.03) 0.54 93.45 CCC 0.17 (4.02) (5.83) 79.10 D (9.45) (1.48) (37.74) 42.13 S&P/LSTA 100 0.01 (1.05) (1.55) 89.11 First-lien (0.18) (0.83) 0.60 93.16 Second-lien (0.24) (1.90) (4.37) 82.37

Source: S&P Capital IQ LCD.

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Another factor weighing on stressed/distressed paper, managers say, is more assertive oversight from end investors. "Micromanagement" has become a major theme, they say, with collateralized loan obligation (CLO) equity investors and separately managed accounts investors poring over portfolio lists and asking hard questions about what they perceive as overconcentrations in troubled names and sectors. This has contributed to the "sell now, ask questions later" mentality in the secondary market, which has exacerbated price declines in loans with negative headline news or in out-of-favor sectors.

Technical difficulties In the words of the days of rabbit-eared TVs, the loan market is experiencing technical difficulties. It's been a simple case of swelling supply and flagging capital formation.

Consider new issue volume: In November, arrangers allocated $28.9 billion of new institutional loans--including such jumbo deals as Avago Technologies Ltd. at $9.75 billion; U.S. Renal Care Inc. at $2.015 billion; NXP Semiconductors N.V. at $2.7 billion; and T-Mobile USA Inc. at $2 billion--the most since June and up from $15.8 billion in October. Meanwhile, loan repayments fell to a post-credit-crunch low of $2.86 billion from $12.92 billion in October. Note that November's repay tally doesn't include the repayment of SunGard Data Systems Inc.' s approximately $2.3 billion institutional loan, which hit the final day of the month. This paydown will be counted in the December statistics.

Chart 8

With volume up and repayments down, the universe of S&P/LSTA Index loans expanded by $19.9 billion in November to

December 4, 2015 12 32871550 | 270752268 The Federal Reserve Will Be Taking Cues From What Should Finally Be An Unbridled Yield Curve In 2016 Lookout Report from Global Markets Intelligence a record $875 billion. It's the biggest monthly increase in supply since May 2014 when the index grew by $22.5 billion.

Chart 9

On the other side of the technical ledger, demand remained anemic. CLO issuance, for instance, sagged to $4.51 billion from $7.3 billion in October. By comparison, managers printed $10.4 billion a month of new vehicles in the first half.

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Chart 10

At the same time, retail investors were again net sellers of loans. During the first four weeks of November, loan mutual funds that report weekly to Lipper FMI posted $1.73 billion of redemptions after withdrawing $0.75 billion in October.

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Chart 11

Beyond these visible sources of capital, managers say that institutional allocations have stalled in recent months despite the promise of rate rises. Pension funds and other investors, they say, are guarded in response to volatility in the broader markets. As well, outflows from speculative-grade funds continued in November--to the tune of $1.6 billion, according to Lipper--reducing crossover demand for loans.

Looking ahead, the technical outlook isn't brilliant for the final month of the year. On the supply side, the deal pipeline remains elevated, though down from the recent post-credit-crunch highs. Leveraged Commentary and Data's forward calendar of merger and acquisition (M&A)-related loans, for instance, retreated to $47.4 billion in November from a post-credit-crunch high of $56.8 billion a month earlier but remained at the wide end of the lagging 12-month range. The bulk of the calendar is expected to be 2016 business, given the recent challenging market conditions.

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Chart 12

Demand, meanwhile, is likely to limp to the finish. One bright spot is repayments, which are set to increase with the SunGard Data Services take-out and a prospective take-out from Interactive Data Corp. for nearly $1.9 billion toward year-end. Still, the once mighty CLO engine is now puttering along. Indeed, managers say placing new equity has become extremely challenging, especially with business development companies largely on the sidelines as a result of declining net asset values. With the secondary market for CLO equity on its heels--with managers reporting seasoned 2.0 paper trading in the 60-70 range--new issue equity is being marketed in the 80s with bids generally inside of that. In addition, CLO liability spreads have widened with 'AAA' paper clearing in the mid-150s to mid-160s from 140 bps above LIBOR earlier in the year. No wonder CLO formation has receded in recent months despite the fact that 96% of index loans are being bid below par.

As for retail money, investors are clearly pulling in their horns on speculative-grade in part because of rising rates but have yet to pull the trigger on fresh loan investments. As noted above, outflows from loan funds accelerated to $1.73 billion in November, according to Lipper, from $748 million in October. Managers generally expect this modest pace of retail redemptions to persist during the final stretch of 2015 and into early 2016 even if the Federal Reserve raises the funds rate by 25 bps, as many economists expect, in December. Mom-and-pop investors and brokers, sources say, have gotten the joke that it will take a few rate increases before LIBOR exceeds floor levels and may, therefore, refrain from piling into the asset class until it's clear the Fed intends to consistently raise rates through 2016.

Managers say institutional investors are also holding their powder until rates actually start moving higher. In addition,

December 4, 2015 16 32871550 | 270752268 The Federal Reserve Will Be Taking Cues From What Should Finally Be An Unbridled Yield Curve In 2016 Lookout Report from Global Markets Intelligence managers say that these accounts are increasingly concerned that the default cycle is nearer to the end than the beginning and, as a result, are taking a more cautious stand on credit.

Looking ahead to 2016, the outlook is hazy. Most participants believe the fundamentals of the market will remain solid. Defaults, they speculate, will remain below trend and concentrated around such struggling sectors as energy, commodities, and specialty retailers.

Technical conditions, however, are as always a wild card. CLO issuance has proved resilient time and again, though the full force of risk retention will clearly become a major factor in 2016. Market participants are also closely watching the Fed because a modest rate hike has the potential to erode returns to CLO equity investors. Unlike the loans in the vehicles, CLO liabilities don't have LIBOR floors. So assuming three-month LIBOR rises slightly following a 25 bps rate hike, the coupons being paid to CLO noteholders would increase, but unless three-month LIBOR rises materially from 40 bps today, the increase in interest income would be minimal, what with 92.6% of index loans including floors with an average floor of 100 bps.

As for retail and institutional inflows, there's potential upside if the Fed raises rates and no outside shock drives liquidity to the sidelines. Naturally, the trend could continue to be negative if sentiment erodes or the Fed is more dovish than expected.

As this all implies, conviction is lacking in either direction. Players would prefer to put 2015 behind them with a small gain and live to fight another day in 2016.

Energy Future Holdings effect Returns in 2015 are less weak than they appear when Energy Future Holdings, the former TXU, is taken into consideration. The pre-petition term debt of Energy Future Holdings unit Texas Competitive Electric Holdings Co. LLC (TCEH), by dint of its massive size and falling secondary price, is on track to be the most influential S&P/LSTA Loan Index constituent on record. As of Nov. 30, the TCEH debt single handedly reduced index returns in the first 11 months of the year by 0.745 percentage points to 0.37% from 1.15% excluding TCEH.

There are three reasons for TCEH's outsized impact. First, the TCEH credit is the largest member of the S&P/LSTA Index despite a low price point that reduces its market capitalization.

Second, the TCEH bid had fallen to 33.96 on Nov. 30 from 64.54 at the end of 2014, according to Markit, as a result of collapsing natural gas prices, technical issues surrounding its size--what with CLOs feeling pressure to reduce 'CCC' and defaulted holdings--and heightened investor scrutiny on distressed and defaulted names.

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Chart 13

Loans versus other asset classes With investor expectations shifting to a Fed move in December, the 10-year Treasury yield climbed five bps to 2.21% on Nov. 30 from 2.16% a month earlier. As a result, loans outperformed the three fixed-income asset classes we track here monthly.

That left returns in the year to date for each of the five asset classes we track here within close proximity with equities in the lead and speculative-grade bringing up the rear. On the whole, however, it's been a year of treading water.

Table 5 Returns

October 2015 (%) November (%) Year to date (%) S&P/LSTA Index (0.18) (0.88) 0.37 BAML High-Yeld Master 2.73 (2.24) (2.12) 10-year Treasury (0.63) (0.51) 1.21 S&P 500, including dividends 8.44 0.30 3.04 BAML High-Grade Corp. 0.54 (0.22) 0.24

BAML--Bank of America Merrill Lynch. Sources: S&P Capital IQ LCD and Bank of America Merrill Lynch.

Looking at risk-adjusted returns, loans remain ahead of equities but continue to lag behind the fixed-income categories for

December 4, 2015 18 32871550 | 270752268 The Federal Reserve Will Be Taking Cues From What Should Finally Be An Unbridled Yield Curve In 2016 Lookout Report from Global Markets Intelligence the Sharpe Ratio of the various asset classes since the commencement date of the S&P/LSTA Index in 1997. The fixed-income categories have all received a major boost from the fall in the 10-year rate from 6.34% at year-end 1996.

Table 6 January 1997 To November 2015 Returns

Annualized returns (%) Standard deviation (%) of monthy returns Sharpe ratio S&P/LSTA Index 5.01 1.75 0.45 BAML High-Yield Master 7.04 2.66 0.51 10-year Treasury 5.92 2.13 0.49 S&P 500, including dividends 8.41 4.49 0.39 BAML High-Grade Corp. 6.28 1.54 0.75

BAML--Bank of America Merrill Lynch. Sources: S&P Capital IQ LCD and Bank of America Merrill Lynch.

Big movers The largest contributors to Index returns included several large names that recovered from recent lows. Valeant Pharmaceuticals International Inc. topped the leaderboard as the credit recouped some recent losses following a string of negative headlines, while La Frontera Generation LLC's term loan spiked to the mid-90s late in the month on news TCEH subsidiary Luminant Holding Co. agreed to purchase La Frontera Holdings. Millennium Health LLC advanced after the company filed for Chapter 11, and Murray Energy Corp. recovered some losses after sliding in late October on news that Foresight Energy L.P. announced plans to suspend dividend payments to all of its subordinated units, including Murray. Rounding out the top five was Avaya Inc., which traded higher on its better-than-expected fourth-quarter results.

As for the largest detractors to index returns, disappointing quarterly results and lower oil prices made a mark. iHeart Communications Inc. (formerly known as Clear Channel), among the largest issuers in the loan market, was the largest detractor from index returns by a wide margin as its loans traded off after its third-quarter miss, and Cumulus Media Inc. and Scientific Games Corp. also took a beating on their quarterly results. Also among the top 10 detractors were Syniverse Technologies Inc., which slid after the company disclosed it lost a customer, and J. Crew Group Inc., which slid amid a negative bias toward the retail sector.

Table 7 Big Movers (November)

Up Standard & Poor's loan rating August Index return contribution Valeant Pharmaceuticals International Inc. BB 0.0183 La Frontera Generation LLC B+ 0.0172 Millennium Health LLC D 0.0126 Murray Energy Corp. B+ 0.0122 Avaya Inc. B 0.0042 24 Hour Fitness Worldwide Inc. B+ 0.0040 Mallinckrodt Inc BB+ 0.0036 Cooper Gay Swett & Crawford Ltd. B- 0.0035 CITGO Petroleum Corp. B- 0.0035 Chemours Co. BBB- 0.0034

Down Clear Channel Communications Inc. CCC+ (0.0850) Ameriforge Group Inc. B- (0.0367)

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Table 7 Big Movers (November) (cont.) Cumulus Media Inc. B- (0.0278) SeaDrill Partners LLC BB- (0.0274) Syniverse Technologies Inc. B+ (0.0266) Scientific Games Corp. BB- (0.0248) Ocean Rig UDW Inc. B (0.0244) Templar Energy LLC CCC+ (0.0243) Fieldwood Energy LLC BB- (0.0213) J. Crew Group Inc. B- (0.0212)

Source: S&P Capital IQ LCD.

Contact Information: Steve Miller, Managing Director--Leveraged Commentary And Data, [email protected].

Follow Steve on Twitter (@millerLCD) for an early look at LCD analysis and for market commentaries.

R2P Corporate Bond Monitor

In the month when U.S. GDP growth was revised upward to 2.1% (previously at 1.5%; the second quarter was 3.9%), more recent data illustrated mixed economic improvement as the clamor for rate rises in December's FOMC meeting was sustained. Domestically, strength in the labor markets continued and still supported spending as retail sales remained positive in October with a 0.1% rise, similar to the prior month. Headline inflation, however, has languished near zero with the Consumer Price Index reading 0.2% for October, up from 0% for the year ended in September. Without food and fuel, which have held back these headline figures for most of the past three years, core inflation was 1.9% with higher airfares and medical care driving much of the increase. Industrial production continued to show overall weakness, falling 0.2% in October; however, the data was fragmented with increases in construction supplies, manufacturing, and motor vehicles--all indicators of economic and consumer strength. Despite these areas of strength, the ISM manufacturing index indicated contraction in November's report as it fell to 48.6 from 50.1 with a dip in new orders and exports continuing to contract. The nonmanufacturing ISM also cooled in November, but growth remained steady at 55.9, having moderated to more sustainable levels following the past few months of high readings (59.1 in October).

Table 8 North America Risk-Reward Profiles By Sector*

Scores (%) OAS (bps) PD (%) BP Vol. (%) Consumer discretionary 29 14 (0.232) (0.101) Consumer staples 12 7 (0.192) (0.075) Energy 40 16 (0.225) (0.229) Financials 21 (1) (0.012) (0.135) Health care 18 16 (0.948) (0.100) Industrials 23 10 0.132 (0.075) Information technology 12 (5) 0.759 (0.079) Materials 33 26 0.110 (0.087) Telecommunications services 20 28 0.041 (0.147) Utilities 13 17 0.244 (0.100) Average 22 13 (0.032) (0.113)

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Table 8 North America Risk-Reward Profiles By Sector* (cont.) *One-month average Risk-to-Price score and components changes to Nov. 27, 2015. OAS--Option-adjusted spreads. bps--Basis points. PD--Probability of default. BP Vol.--Bond-price volatility. Source: S&P Capital IQ.

In the eurozone, heightened geopolitical and extraneous events have taken center stage, but economically, the situation appeared largely stable in November, according to the balance of data, despite PMI figures continuing to show strength. Official figures showed the eurozone economy expanded by a lukewarm 0.3%, quarter over quarter, for the three months ended September 2015. The growth rate dropped from 0.4% in the second quarter and 0.5% in the first quarter of the year owing to weaker international trade and exports, mainly from Germany and Italy, along with France's continued weak recovery. November's PMI data again showed some surprising strength with the composite reading rising for the third consecutive month. The composite index rose to 54.4 from 53.9 in October, maintaining a steady pace of growth as output rose for both services and manufacturing. The report hinted toward better job creation. The service sector PMI rose to 54.6 in November from 54.1 in October, and the manufacturing PMI rose to 52.8 from 52.3 with the output index also rising.

Table 9 Europe Risk-Reward Profiles By Sector*

Scores (%) OAS (bps) PD (%) BP Vol. (%) Consumer discretionary (2) 8 0.027 (0.047) Consumer staples 14 4 (0.017) (0.032) Energy 17 23 0.003 (0.062) Financials 12 (1) (0.011) (0.034) Health care 8 15 0.008 (0.021) Industrials 3 (1) 0.002 (0.031) Information technology 15 24 (0.014) (0.113) Materials 19 (6) (0.022) (0.122) Telecommunication services 16 (2) (0.017) (0.033) Utilites 2 (2) 0.038 (0.065) Average 11 6 (0.000) (0.056)

*One-month average Risk-to-Price score and components changes to Nov. 27, 2015. OAS--Option-adjusted spreads. bps--Basis points. PD--Probability of default. BP Vol.--Bond-price volatility. Source: S&P Capital IQ.

Despite some mixed economic data in the U.S. and geopolitical risk in Europe, the uptick in U.S. GDP growth estimate and the steady economic situation in the eurozone could explain the positive changes experienced in bonds' risk-reward profiles in the month ended Nov. 27, 2015, in both Europe and North America. Risk-reward profiles overall have improved as volatility has decreased in recent weeks and spreads have widened across the board.

In North America, the risk-reward profile improved as a result of wider spreads and improving market risk (as measured by bond-price volatility) as credit risk remained fairly stable overall (as measured by the probability of default).

Europe's overall risk-reward profiles also improved in the month, driven by wider spreads overall. Both market and credit risk remained stable in the month.

For more of our market views and sector credit opinions, please see our monthly Fixed-Income Strategy: "More Quantitative Easing Looms For The Eurozone; The U.S. Case For Fed Action Strengthens," published Dec. 2, 2015.

Fabrice Jaudi, Vice President--Global Markets Intelligence, [email protected].

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Kunaal Vora, Credit Research Analyst, London +44(0)207 176 8317; [email protected].

Capital Market Commentary: IPOs, M&A, And Debt

IPOs Underwriting activity for IPOs retreated in November in both number of new issues and proceeds raised. According to S&P Capital IQ data, 11 IPOs came to market last month and raised $1.24 billion. In contrast, October saw 17 IPOs completed on major U.S. exchanges with total proceeds of $5.32 billion led by First Data Corp.'s $2.56 billion offering. For the first two months of the fourth-quarter 2015, 28 IPOs have been priced with total proceeds of $6.56 billion compared with 51 IPOs raising $9.76 billion in October and November 2014. Looking ahead to December activity, recent historic performance suggests a modest month for IPOs. Since 2010, December has seen, on average, 10 offerings priced with average proceeds raising $3.2 billion. Among expected offerings include Australian software firm Atlassian Corp. PLC, which filed plans for a $250-million offering on Nov. 9.

Table 10 November 2015 IPOs

Total transaction value Price per share Recent clost price Effective date Target/issuer (mil. $) ($) ($) Change (%) 11/10/2015 Voyager Therapeutics Inc. 70.0 14.00 25.19 79.90 11/10/2015 Advanced Accelerator Applications 75.0 16.00 26.44 65.30 S.A. 11/18/2015 Square Inc. 243.0 9.00 12.04 33.80 11/18/2015 Match Group Inc. 400.0 12.00 14.48 20.70 11/19/2015 Duluth Holdings Inc. 80.0 12.00 14.35 19.60 11/12/2015 Instructure Inc. 70.4 16.00 18.74 17.10 11/12/2015 Xtera Communications Inc. 25.0 5.00 5.41 8.20 11/10/2015 Equity Bancshares Inc. 43.7 22.50 24.19 7.50 11/10/2015 WAVE Life Sciences Pte. Ltd. 102.0 16.00 16.25 1.60 11/18/2015 Mimecast Ltd. 77.5 10.00 10.11 1.10 11/19/2015 Axsome Therapeutics Inc. 51.0 9.00 8.83 (1.90)

Source: S&P Capital IQ.

M&A Big deals dominated November M&A activity. According to S&P Capital IQ data, 26 deals worth $1 billion or greater were announced. That matched October's count for deals of that size and stands only behind July (34 deals) for deals of $1 billion or greater taking place this year. Among active acquirers in the past month include Pfizer Inc. entering into a definitive merger agreement to acquire Allergan PLC for approximately $190 billion on Nov. 22, Canadian Pacific Railway Ltd. making an offer to acquire Norfolk Southern Corp. for $28.2 billion on Nov. 17, and Marriott International Inc. entering into a definitive agreement to acquire Starwood Hotels & Resorts Worldwide Inc. for $11.7 billion in stock and cash on Nov. 15, 2015. Looking ahead, will the month of December see a slowdown in U.S. M&A activity? Through the first 11 months of 2015 only January had less than $100 billion in announced deal value as $94 billion in transactions took place that month. However, since 2010, December has averaged $88 billion in announced U.S. M&A. Although the specter of a modest interest rate rise and anxiety about deal valuations may give pause to deal activity, the appetite for acquisitions may only be eased in the near term as buyers digest their previous acquisitions.

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Table 11 November 2015 U.S. Mergers And Acquisitions Summary

Most active buyers/investors by number of transactions

Total transaction size (mil. Company name Number of transactions Company name $) Capital Senior Living Corp. 5 Pfizer Inc. 190,971.09 Phillips Edison - ARC Grocery Center REIT II 5 Canadian Pacific Railway Ltd. 38,026.63 Inc. Farmland Partners Inc. 4 Marriott International Inc. 14,048.68 Healthcare Realty Trust Inc. 4 Targa Resources Corp. 13,609.85 Canada Pension Plan Investment Board 3 L'Air Liquide S.A. 13,192.09 Charles Tunkieicz Farms Inc. 3 Molson Coors Brewing Co. 12,000.00 CIM Group Inc. 3 Weyerhaeuser Co. 11,725.48 Gladstone Land Corp. 3 Canada Pension Plan Investment 7,436.00 Board Invesco Real Estate Ltd. 3 Shire Pharmaceuticals International 6,539.25 John and Joann Horton Family Ltd. Partnership 3 CVC Capital Partners Ltd. 4,600.00

Number of transactions by sector Energy 57 Materials 41 Industrials 165 Consumer discretionary 202 Consumer staples 50 Health care 126 Financials 540 Information technology 172 Telecommunication services 6 Utilities 15 No primary industry assigned 91

Merger and acquisition statistics Total deal value (mil. $) 375,007.97 Average deal value 599.05 Average total economic value/revenue 7.83 Average total economic value/EBITDA 14.63 Average day prior premium (%) 43.63

Number of deals by transaction ranges Greater than $1 billion 26 $500 million-$999.9 million 8 $100 million-$499.9 million 87 Less than $100 million 506 Undisclosed 838

Source: S&P Capital IQ.

Debt The pace of recent new orders for security identifiers for a variety of debt offerings saw a modest uptick in November

December 4, 2015 23 32871550 | 270752268 The Federal Reserve Will Be Taking Cues From What Should Finally Be An Unbridled Yield Curve In 2016 Lookout Report from Global Markets Intelligence based upon information provided by Committee on Uniform Security Identification Procedures (CUSIP) Global Services. CUSIP demand for forthcoming municipal issues saw mixed results as municipal bond security identifier orders rose last month. Meanwhile, short-term municipal note demand slipped in November (see table X). For municipal bond CUSIP orders, the recent monthly showing was the best performance since July when 1,233 CUSIPs were sought. Similarly, domestic corporate debt CUSIP requests rose to 705, which ended a three-month period when identifier demand for this asset class failed to crack the 700-level. In this regard, the anticipation of higher borrowing costs ahead may finally be propelling corporations to take action.

Table 12 Selected CUSIP Requests

Asset type November 2015 October 2015 2015 2014 Year-over-year change (%) Domestic corporate debt 705 669 8,659 8,812 (1.74) Municipal bonds 1,147 1,111 13,765 11,552 19.16 Short-term municipal notes 96 127 1,299 1,363 (4.70) Long-term municipal notes 15 13 330 563 (41.39) International debt 180 199 2,652 2,574 3.03 PPN domestic debt 142 131 1,898 2,140 (11.31) Total 2,285 2,250 28,603 27,004 5.92

CUSIP--Committee on Uniform Security Identification Procedures. PPN--Private placement number. Source: CUSIP Global Services.

Contact Information: Rich Peterson, Senior Director--Global Markets Intelligence, [email protected].

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