11th December 2015

Looney Tunes

MARKET CLOSE:
FTSE 100
6,088, -39
DAX
10,599, +6
S&P 500
2,052, +4
iTraxx Main
76bp, +1bp
iTraxx X-Over Index
319bp, +7bp
10 Yr Bund
0.57%
iBoxx Corp IG
B+150.6bp, +0.5bp 
iBoxx Corp HY Index
B+495bp, +7bp
10 Yr US T-Bond
2.23%

That’s all folks… We’re closing up for the year in this final comment for 2015. The year hasn’t turned out as expected – far from it – but performance has recovered in most asset classes from the lows we saw through the second and third quarters. However, looking at the predictions we had at the start of 2015, only equities have returned what most envisaged (9-10%+) – and that figure hides many ills. That is, German stocks were up 25% at one stage, then down 3% and now are in the +10% arena YTD. Investment-grade credit has been up over 1%, down 0.75% and is now -0.6% YTD on initial expectations that 2.75-3% returns were possible on 20bp of index tightening this year. The IG index widened by 40bp. The high yield market has seen spreads widen too, but the strength of the front end of the underlying has kept performance positive and up at +2% YTD, with few defaults to trouble us (in European credit anyway). The year has been one of concerns about US interest rates – and this has been a consistent theme – hitting EM currencies hard, serving up bond market volatility, leaving equities jittery and at times helping crush the US high yield market. There has been a divergence between policy in the US and just about everywhere else. Chinese growth dynamics have become more of a pressing issue through the year and will likely be the biggest factor for risk asset performance in 2016. Global growth will possibly disappoint again; we are not optimistic about it. Bond yields in the eurozone will remain low and most likely head lower. That’s because we believe the ECB will soon be back in action and filling up its shopping trolley some more. Inflation is non-existent and will remain so through next year. Commodity prices, if nothing else, will see to that. Throw in high levels of consumer, corporate and government indebtedness, weak capex and investment, lack of real structural reform, monetary policy becoming more ineffective the looser it gets, geopolitical risks and the potential volatility around the Brexit vote, and one can easily see that 2016 threatens to be as – if not more – challenging than 2015. We will be back on the first day of business with some forecasts as to where and how we think markets will play out in 2016…

Credit poked us all in the eye… We got the Markit iBoxx index call right – for a quarter, when spreads tightened almost 20bp (our forecast for the full year) from B+111bp to B+94bp. But it went awry after, and we are currently languishing at B+150bp. There might be 3 weeks left to year-end, and if the index ends at B+145bp, that will be a result. Returns YTD are -0.6% and we can’t see them deviating much more from that. In all, not a great year, especially when we throw in the devastation caused by the VW scandal and the commodity carnage beating up the likes of Glencore and Anglo American. For HY, returns are up at 2% but spreads are 50bp wider. The index has “traded” with a 3-handle and a 5-handle! Defaults have stayed well below 3% and any weakness has really come from the contagion impact of US HY, and in particular from US shale gas sector woes. We think it will be the same story in 2016, with the wall of funding having been pushed out to 2017/18, helping alleviate financing and refinancing concerns in the sector. For next year, we think 20bp of tightening could deliver 2.5% or so of total return in IG credit. Recovering this year’s weakness with 40bp of tightening and we would be looking at 3.25% – but for that, we need a rally in the Bund. That’s not entirely impossible. We will flesh this out in our opening New Year note.

New issues deliver… For IG non-financial supply, the Eur268bn (Dealogic) of issuance represents the second best year ever for issuance in the euro-denominated market. It is only Eur16bn shy of the record from 2009. That’s a fantastic level, and illustrates how the corporate bond market in Europe has become a core asset class and exhibited a fair degree of resilience. Investors have become buy-and-hold players, but not plagued too much by way of outflows, and with most still seeing net inflows on an annual basis, the market can continue to be well-supported as the disintermediation of funding trend continues. The HY market delivered Eur48.5bn of new bonds and is just Eur100m away from leaving 2015 as also the second best year ever for supply (after last year – all Dealogic data). Admittedly, the second half has not been great, as global growth, rate and event-risk jitters have impacted sentiment in the asset class. Still, yields have backed up in European HY to close on 5% (Markit iBoxx) and we think represent an interesting opportunity, liquidity permitting. For next year, our early thoughts are for similar levels of issuance in HY, but perhaps a touch lower for IG, at Eur230-250bn.

Secondary market liquidity changes face of market… 2015 was about the worst year ever for secondary market liquidity. The squeeze on the banks as they sought to divert risk capital away from market operations to shore up their defences in the event of another crisis has changed the nature of the business – and the way it is done. The political machine has forced the regulatory one to make the markets less efficient, in the traditional sense. We just have to get used to the new way of thinking and investing. For corporate bond investors our raison d’etre is now as buy-and-hold players. Our business is not going to be commoditised like the equity market or like the government bond and FX markets. Few will sell into macro weakness or jitters, because those bonds will be gone forever. Save for a bit of juggling around the edges of a portfolio, expect volumes and turnover to decline even further. Primary is all that will matter. Our crisis will be rotation, from credit to equity. See signs of a sustained uptick in growth? Then why invest in low-yielding corporate bonds? Equities will be on the up as one changes to strategies for capital growth and away from income. That is when one should afraid. Retail players which are now 10-15% of the market will be first to blink. The rotation into equity might have a bigger impact on asset managers with retail portfolios, given that investors into institutional mandates will be locked in (some have probably already shifted funds to real estate and so on). We believe we can afford not to worry in 2016.

The bug-bear around the lack of secondary market liquidity are the violent moves which can virtually ruin ones entire annual performance. This is a problem for all investors and especially the buy-and-hold type. Even over these past few sessions we have seen some quite massive moves in selected bonds and ones not even impacted by the commodity sector. For example, the Lloyds 6.385% 2020 down 8-points, Monte dei Paschi’s 5% 2020 off 7-points and the Glencore 1.75% 2025s moving in the other direction, up 4-points. Selling cares have been small and typically from retail players. The modus operandi sees the Street take screen prices points lower in order not to get hit or avoid even being asked. They’re unhelpful and understandably so. The point is, sell when you can and not when you have to – even if it means a multi-point hit, because the chances are the issue could be down another several-points the next day!

That’s it. This website is 14 weeks old, has 706 email subscribers and has had close on 29,000 hits. We do not advertise. We do hope you have enjoyed my thoughts and that they have helped in some way in your own investment decisions. Good luck with the Fed decision next week. Wishing you a merry Christmas and a happy New Year. I turn 50 today – I need beer.

Suki, Alan and Caroline

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.