14th October 2015

High Yield or Emerging Markets?

MARKET CLOSE:
FTSE 100
6,342, -29
DAX
10,033, -87
S&P 500
2,004, -14
iTraxx Main
80bp, +2bp
iTraxx X-Over Index
331.5bp, +8.5bp
10 Yr Bund
0.59%
iBoxx Corp IG
B+159.5bp, +0.5bp 
iBoxx Corp HY Index
B+507bp, +1.5bp
10 Yr US T-Bond
2.04%

European high yield versus emerging markets… Corporates in both sectors occupy the same arena in terms of slowing global growth dynamics affecting the top line. The top line matters because it helps generate that cash buffer needed to feed interest payments. And the Chinese import numbers (-20% yoy in September), should have the warning bells ringing for everyone – if they weren’t already doing so. The Fed will be listening, the ECB will be readying plans to extend the scope of its QE programme, investors will be fretting about risk asset valuations and central banks generally wondering what next. Zero interest-rate policy hasn’t quite worked out how we all hoped. They’ve pushed on that string for so long and in so many ways that we’re not far off the point where they might try something completely unconventional. That’s the hope, anyway. In the meantime, China’s economic slowdown will have repercussions throughout the emerging markets, while the developed ones will also feel the heat but remain better protected against the slower growth dynamic for a little longer (that’s why they’re called ‘developed’). In credit, corporate dynamics are going to come under pressure and we don’t see any heroism in trying to pick off cheap EM corporate bonds. You won’t be thanked for it. A better option, in our view, would be European HY, especially for buy-and-hold investors. The double-Bs continue to offer value (low default risk too), as do good single-Bs. Europe will more than likely slow again, but unless growth is hit by a cliff-event, the HY sector for the “widget-making” entities will manage to scramble across the line. These corporates usually have a business that can withstand an extended period of low(er) growth.  We are back in the investment process, where we are looking for incremental yield and a relatively safe asset. There’s much to be said for these solid companies, despite their higher leverage.

UK inflation dips into negative territory again… No rate rise in the UK any time soon, and the bid for sterling corporate bonds will also remain intact – but from the traditional players. Tuesday’s inflation numbers will see to it that the BoE is sidelined for a good while yet. Sterling credit has outperformed euro-denominated credit this year while displaying hardly anything like the same level of volatility. Unfortunately, the sterling corporate bond market is quite small and is a longer duration market, more illiquid than euros/dollars and controlled by a few large players. The information ratio is low. We don’t expect traditional euro investors to move over looking for better pickings for those reasons, but those who do/can will find value.

Slim pickings still in primary… Dutch electricity grid operator Enexis was the sole corporate borrower, with a Eur500m no-grow deal at midswaps+87bp off a Eur3bn book. The deal was tightened up from an IPT of midswaps+95bp, so good for the borrower and good for the syndicate championing the success of the demand. Not so great for the investor, left holding the baby as we move on to the next deal. This is always the case. Anyway, the current level of corporate issuance, at just over the Eur2bn mark for the month to date, is extraordinarily low, given that we have averaged Eur15bn (Dealogic) per October since 2010. The corporate bond market isn’t exactly in panic mode, but there have been some increased levels of idiosyncratic risk, macro leaves much to be desired and the next Fed meeting looms large. There are deals to get done, but as we suggested last week, blue chip issuers don’t want to be first up on the screen with cheap deals. The shame of it!

No Super Tuesday, let’s hope for a happier Wednesday … So the much lower than expected Chinese import numbers saw to it that we had a tougher session on Tuesday. Equities reacted as we would expect – lower. The weaker German ZEW business survey didn’t help, but it is less of a forward indicator. The UK inflation report added to the general feeling of malaise. Johnson & Johnson announced a $10bn share buyback programme but missed on earnings and InBev finally got its hands on SABMiller. In secondary, we saw some weakness, but generally outperformance with few willing to let bonds go and few willing to offer. Illiquid markets have a habit of making sure we keep our heads while others maybe losing theirs! The slight widening was noise in the big scheme of things.

And finally, JPMorgan Q3 missed, US stocks closed in the red… and Intel was upbeat for its Q4 revenues. Primary will make our day. Have a good one.

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.