- by Suki Mann
iTraxx X-Over Index
10 Yr Bund
iBoxx Corp IG
iBoxx Corp HY Index
10 Yr US T-Bond
Chapter 5: Keeping risk positions anchored
Supply, demand and a bit of post-election euphoria captured the imagination (and valuations) of the corporate bond market into the end of April.
Spreads in IG credit as measured by the broad Markit iBoxx index tightened by a massive 5bp in the aftermath of the election result – and in the top 20 of the biggest daily index moves for any given period, ever. The index tightened by 10bp overall last week to B+121.8bp and is the lowest level since October 2016. And that is also after barely any tightening – this year anyway – before it.
It’s most welcome, but why? Clearly, there was a better bid for corporate risk once the result of that first round of the French election was known. And an excited Street – light on inventory – would have aggressively firmed up any offer-side levels. Hence the big move.
But also, there might have been a little concern (suddenly) that IG non-financial supply has been low. Actually, April’s piddly €5.6bn of issuance is one the lowest months ever for supply outside a July/August/December holiday period and therefore bit of a scramble to use up some residual cash positions.
In fact, the high yield market did even better. The index level dropped a stunning 18bp. Interestingly, we have had a decent level of issuance in this market in April, at just over €6bn, but that didn’t stop the market rallying as hard as it did. It helped that equities – the CAC for example, rallied almost 5%. The index now resides at the 2017 lows to B+347bp (and lowest level since the summer of 2014) as the market eventually steadied and reflected, but the omens are good for a continued tightening of spreads in high yield into the sustained improvement we’re currently seeing in macro.
So, overall, supply has been mixed between the two markets – high yield issuance for the month exceeding that of the investment grade market for the first time ever – while the spread direction has been the same with outperformance in the high yield market. For May, we can expect the direction in spreads markets to follow the same path but checked, perhaps, in how much we get depending on the level of primary activity. There might be a wobble into the end of this week ahead of the second round of the French election, but if we believe the polls then a Macron victory is assured and the ship continues as is. No change (and that’s not necessarily a good thing), that is.
So stay long portfolio beta, with a slightly longer duration positioning and debt holdings skewed heavily towards lower rated issues.
May primary to correct supply/demand imbalance
The Easter holiday period and French election notwithstanding, the last two weeks of April delivered just one deal of €300m. This is financial system crisis-like supply dynamics! We’ve had a zero month before, but that was at the height of the global financial crisis and happened in August 2008. But €5.6bn in April is poor however we look at it (see charts).
Some will point to the Q1 earnings blackout period for the lower levels of issuance but, if this theme is real and stays with us, we could expect a lighter month again for May. We don’t buy it. After all, the April months in the period 2014-2016 delivered €16bn, €27bn and €30bn each (albeit not impacted by late Easter or elections). Our point is, we could – ought to – have had higher levels of investment grade non-financial issuance.
We think that primary markets need to deliver in May, and if they don’t then spreads will go tighter, materially introducing their own frustrations for investors who would prefer spreads to hold at these or even slightly higher levels. After all, spreads are tight by any measure, but then they have been for several years.
The imbalance between supply and demand might/will possibly see the index down at closer to B+110bp (from B+123bp currently) should primary not pick-up materially. We have just the second round of the French elections standing in the way of a month that should/could deliver €30bn+ of issuance.
Performance exceeding expectations
Equities have had a very good opening four months with the €Stoxx50 returning a stellar 8.1% and the DAX some 8.2%. They both languished for much of 2016 before a bit of a late comeback as we closed out last year. German equities, in particular, are in the ascendancy on hopes that the Eurozone is back on an assured growth footing.
The FTSE hadn’t done too badly amid Brexit concerns and some currency volatility, but after being up 2.6% in the opening three months of the year, it has fallen back to return 0.6% in the period to the end of April largely on growth concerns.
The US stock indices have hit a multitude of closing highs in the four months to the end of April, but dithering over Trump’s geopolitical agenda, rate hike uncertainty (and we think, now, growth concerns) has prevented them going much higher – although forward P/E valuations are very stretched. With all that, +6.5% for the S&P in represents a very good effort!
In fixed income, Eurozone sovereigns overall total returns are at -1.1% with the performance worsening in April as yields backed up. While negative, it could have been a lot worse. It is still a relatively decent performance given the potential for a growth inflation and higher rate dynamic that the asset class faces. After all, fixed income is going to feel some performance pressure in 2017.
In credit, the Markit iBoxx IG corporate bond index closed the month at B+121.8bp – or 8bp tighter in the month. Investment grade returns, as measured by the index, have improved to +0.6% for the four months from +0.1% for the quarter. The improvement came from all sectors non-financials (+0.6% to, for example), while financials have had the best of it and are up 1.15% in the year to end April.
The high yield market, though, is where the action is and tops the fixed income performance charts. Total returns for the year to end April are up at 2.7% (versus +1.6% to end March) and ahead of the sterling market where performance comes in at 2.6%. The latter is a longer-duration market and has benefited from the rally in Gilts, given that spreads are largely unchanged (market iBoxx index) this year. In euro-high yield, the shorter duration nature of the market has helped, but spreads have rallied hard, by some 70bp already this year.
And the rest…
We think that the week will be light in terms of activity because there is plenty ‘happening’ for markets to focus on. If anything, positioning might be a little defensive. We have the FOMC coming up – expect no change in policy. Non-farms finishes us off on Friday and after the previous rather poor report, markets are expecting a bounce back to close on 200k jobs being added.
We have the earnings season still ongoing – and accelerating with the likes of Apple, Pfizer and Kraft all due. The second round of voting in the French election is next Sunday.
Last week, the BoE completed its £10bn corporate bond purchase programme some eleven months ahead of schedule, but did succeed in coaxing the primary market out of its previous slumber. Spreads have barely moved though in the steering space, and it will be interesting now to witness a grind tighter which might happen if the euro-denominated debt market leads the way.
Finally, the iTraxx indices are holding at lower levels – 66.6bp for Main and 266bp for X-Over.
Have a good day.
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