12th January 2016

Nervous breakdown

MARKET CLOSE:
FTSE 100
5,871, -41
DAX
9,825, -24
S&P 500
1,924, +2
iTraxx Main
86bp, unch
iTraxx X-Over Index
350bp, unch
10 Yr Bund
0.54%
iBoxx Corp IG
B+161bp, +1bp 
iBoxx Corp HY Index
B+548bp, +5bp
10 Yr US T-Bond
2.17%

Suspicion torments the mind… Markets don’t usually gap lower in a straight line for a significant period of time – there’s always a bounce of some sort before we (likely) drop again. And that is how we should view yesterday’s extremely tentative intraday pullback in (equity) valuations in Europe. It’s a wonder we even rallied at all, although we closed in the red eventually. Because this came after Chinese stocks fell by over 5% and oil prices also by almost 7%, while base metals saw new multi-year lows (copper, for example). Still, we had the first senior and subordinated financial deals of the year as well as the first US borrower to chance its arm in the non-financial sector. A few might think about lifting some paper here, bottom-fishing on hope we have the beginnings of a turnaround in sentiment, risk-taking and by extension the economy. We are nowhere near those points, but in credit, one should buy when one can (see below); there will be no offered-side liquidity when everyone else gets interested. Anyway, nothing has changed over the weekend to suggest that equities (for example) are going to stabilise and then recover a good portion of last week’s severe losses soon. We are in for a long hard slog. There was little conviction in the moves, and stocks might have been up, but they did fall back into the red before heading up again. Cash credit held steady, while the iTraxx indices attempted to retrace losses on those slightly better equity moves – all to little avail. A few lows were achieved in the session, as in the case of the rouble (13-month) and the Kazakh tenge (all-time), while those Saudi FX reserves will likely see a precipitous drop in attempts to defend the riyal. No prizes for spotting the connection between all that with the price of a barrel of oil (closing at $31.29 for Brent). At the current rate of decline, oil will be trading with a 2-handle in the next (few) session(s).

Credit worth its weight in gold… We have believed this in the past during these crisis-ravaged years. Fundamentals for the asset class have actually held firm right through, since 2009. Cash-rich, conservative balance sheets, low refinancing risks, low rating transmission trajectories and a low default rate have all been credit’s staple support mechanism. Confidence in the asset class – especially from retail (15%+ of the market) – has come from that default rate, which has been at 3% or lower since 2009 in Europe. That is, corporates have paid up and coupons at 5-8% for IG credit back then have been a welcome source of income for them. The big drop in yields and spreads in 2012-2015 made corporate bonds a less attractive proposition, but principal has almost always been repaid. We have a similar situation now. Yields have backed up from their lows, as have credit spreads. New deals are coming with higher coupons versus the record lows we saw in Q1 2015 – exactly a year ago. There is much paper out there in the secondary market, where single-A and double-A US corporate bonds issued in euros are being shunned and debt trades at 90c or lower on the dollar. The big institutions have been savaged by the price drop, but we think this paper is worth a look for new entrants, or those seeking non-EM exposure at EM-like levels. As long as the global economy – or for that matter the eurozone’s – doesn’t fall off a cliff, IG and good double-B paper will pay back. Stay with the asset class.

Primary opens and we are impressed… We wouldn’t have thought it could happen so quickly, but we are pleasantly surprised by the deals which got away yesterday. General Mills ended up paying nil new issue premium for its Eur500m, 4-year maturity floater (Euribor+73bp) and, as stated above, became the first US borrower to print in euros this year. Why a floater we’re not sure, but the spread was ‘a headline grabber’. In senior financials, BFCM opted for 10-year finding at midswaps+80bp (Eur1.25bn) and Spain’s BBVA took Eur1bn in a 5-year deal at midswaps+85bp. It seems like we want some risk on the books despite the financial market travails and ABN obliged with a 12NC7 T2 deal paying midswaps+245bp for Eur1bn. We’re just missing a HY deal, a CoCo issue and a corporate hybrid to round off the full gamut of structures. They’re the more difficult ones and we will definitely need to wait a little longer – until the markets find a floor and regain confidence – before one appears.

Closing out on a downer, again… The rally in stocks was squarely intraday. The DAX gave up gains of over 1% to close in the red, as did all the other bourses. Another 80 points to go (a session away) and the DAX will be down 10% YTD! US stocks were as choppy and closed only a touch better. Government bond yields rose a little and corporate bond spreads ended only a little wider as evidenced by the Markit iBoxx IG corporate bond index at B+161.25bp (+1bp) while HY saw 5bp of weakness on the index (B+548bp). The iTraxx indices closed unchanged, but they will open at new contract lows given the weakness in equities overnight. Alcoa’s earnings beat expectations, so that might help in the session today.

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.