29th September 2015

Deflating the global asset bubble

MARKET CLOSE:
FTSE 100
5,959, -150
DAX
9,484, -205
S&P 500
1,882, -50
iTraxx Main
91bp, +7bp
iTraxx X-Over Index
375bp, +26bp
10 Yr Bund
0.58%
iBoxx Corp IG
B+166.8bp, +6bp 
iBoxx Corp HY Index
B+536bp, +17bp
10 Yr US T-Bond
2.09%

The much needed shake-up, or something more sinister…? Are we in the throes of a good old fashioned repricing of assets after years of being propped up by artificial means? It isn’t the Fed we worry about – they’re not going to move in October and if they do, it will have little impact. The drip-feeding of bad data from China – today industrial profits at multi-year lows – is threatening to turn into a torrent. They are deflating the global asset bubble. We are snatching defeat from the jaws of victory as concerted global QE has failed to elicit a steady, sustainable rise in growth. The slowdown in China will take in the US much harder eventually, and the might of the German industrial machine is also going to see a significant slowing. That’s before we get into the VW story. It’s a real mess and we’re caught in the headlights. That means no decent bid on anything, poor liquidity exacerbating price action and a fairly depressing read for performance when those month-end marks and client valuations go in. It will be worse for equity-exposed investors. For corporate bond markets, it’s stick to what it says on the packet: Buy and Hold. Clip the coupon. Money back usually assured at maturity. Let’s hope that this is no turning point, that the ship steadies, that the US can weave her magic and we see out the year amid calmer climes. Here’s hoping, anyway.

It’s not a pretty picture, name your price… Yuck. So much for the bounce at the end of last week. Few were convinced anyway, given the lack of positive price action in the corporate market. And so Monday turned out to be a very difficult session as we woke up to news that Chinese corporate industrial profits had fallen almost 9% to multi-year lows. Commodity players took a hammering, with Glencore the obvious first victim. Its stock was down almost 30%, its bonds in free fall, its 3-5 year CDS curve flat and its strategy to dominate the commodity world in tatters. Glencore’s 1.75% 2025 issue was down 6 points, at a cash price of Eur62.5 mid. The situation took in ArcelorMittal (up to 2 points lower), Anglo American (over 40bp wider) and the likes of commodities trading group Louis Dreyfus (+40bp). Oh, and just about everything else, with low-beta risk widening by 3-5bp and high-beta paper by up to 20bp amid little real visibility. VW’s 5-year CDS gapped 30bp (mid 260bp) and its cash bonds by up to 40bp. With news that German prosecutors had opened up a criminal probe into the departed VW CEO and that Audi suggested 2.1 million cars are likely affected by the emissions debacle, the stench of crisis is going to linger around one of the darlings of the German industrial machine. Stay away.

And no global systemic crisis, just a slowdown to contend with…We have an impending global slowdown – again – but this time led by China. And it matters. It is not driven by crisis in the global financial system. Some would say that QE has failed, it just pushed on a string. Whatever, that translates into lower profits and investment, potentially lower employment and a whole gamut of direct and indirect effects on the growth and political front. What about credit? Well, the most important factor is liquidity. There isn’t any. It’s what we feared all along when investors felt the need to exit en masse. The door isn’t wide enough, or rather the bid isn’t deep enough. The political and regulatory response to the 2008 crisis simply got it wrong. Counter-cyclical policies need to be in place, but instead we had a tightening of standards and the creation of an overly defensive banking sector as a result. Capital is expensive, and the banks are not employing it in the same way, or in the same amounts, as they did back in the ‘good old days’. That means we get little appetite for risk from the natural absorber of risk in a crisis scenario – the trading desks. Hence the latest severe price action. It hurts – and it can get worse. Whether it does or not depends on whether we really do see a wholesale exit from the asset class. We don’t think we will. Corporate bonds offer better downside versus equities and better yield than government bonds, and have defensive characteristics which will help them maintain their allure versus the aforementioned alternatives

So nurse losses and wait for the calm to return… Returning calm? That’s a big call on China managing a soft-landing for its economic slowdown, on the VW emissions scandal not snaring others – and on the Fed delaying a rise in rates. Unfortunately, they’re all slow-burning fuses. Other situations will also brought into the fold, but we might get lucky. For now, well, it was a case of battening down the hatches. After the comment we made in yesterday’s note about the iTraxx indices behaving with little of the volatility we’ve seen in stocks, well, they didn’t today! Main was up at 91bp (+7bp) and X-Over rose to 375bp (+26bp), with the old contracts back at their August wides. As well as the aforementioned price actions, it was notable that the VW hybrids were back at their lows, losing 3-4.5 points across the curve, and AT1/CoCo paper was off up to 0.75 points. Nothing was spared. It passed me by that Alcoa is splitting its metals and business, that Vodafone’s tie-up with Liberty isn’t going ahead and that we had a vote in Catalonia, Spain which ought to have been given more attention.

Red mist in the numbers… A sea of red saw the Dax fall 2.1% and through 9,500, the FTSE 2.5% and back through 6,000. In the US, the S&P was down over 2.5% and below 1,900 (-50). The 10-year Bund yield dropped to 0.58%, Bono yields to 1.92% (-11bp) and USTs to 2.09%. The iBoxx IG non-financials corporate bond index closed higher at B+167bp (+6bp) and almost at 2-year highs. The basic resources component of the index was up at B+406bp, or a whopping 100bp wider today! It has doubled this month. The non-financial hybrid index was 26bp wider and the auto index 20bp weaker. There were some safe sectors, but they also might come under pressure if we get (unexpected) fund outflows. As for HY, the index was at B+536bp, some 17bp wider predicated on little news flow worthy of the weakness. Just contagion. And finally, Schipol Airport got Eur300m in 11-year funding away. Ho hum.

Dare I say it. Have a good day.

Suki Mann

A 25-year veteran of the European corporate bond markets and in his role as Credit Strategist, Dr Mann has been ranked number one in the Euromoney Investor Survey eight times in ten years. Previously with Societe Generale and UBS, he now shares views of events in the corporate bond market exclusively here on Credit Market Daily.