24th September 2015

Sea of heartache

MARKET CLOSE:
FTSE 100
6,032, +96
DAX
9,612, +42
S&P 500
1,939, -4
iTraxx Main
80bp, -1bp
iTraxx X-Over Index
332bp, -5bp
10 Yr Bund
0.59%
iBoxx Corp IG
B+156.7bp, +1bp 
iBoxx Corp HY Index
B+506bp, +5bp
10 Yr US T-Bond
2.15%

Pushing on a string… It’s an awful lot of cars – 11 million, and possibly more. But there is no global financial meltdown or systemic crisis, we are far from that situation. Yet the market’s reaction has been incredible on the potential for scandal to engulf most of, if not the entire, auto industry. Some of the pricing action we have seen has been almost Lehmanesque in its magnitude; the rhetoric certainly has been. The global banking system isn’t under scrutiny or impending collapse. A large part of the corporate sector might be. Should the markets be reacting this way? Monetary policy has not been tightened and likely will not be for a while. The liquidity tap is still open and could be opened further if needed. However, as well as the VW emissions scandal, all roads lead east, to China. Wednesday’s poor manufacturing data with activity at a 6.5-year low had stirred at the open. Commodities prices are going to stay low/go lower, and a swathe of industries are going to come under earnings pressure. The knock-on effect has seen Total, for example, announce that it would be cutting capex in light of an expected prolonged decline in oil prices. On Wednesday, markets opened weaker again but then managed a somewhat nervous bounce in a choppy session, most likely on the back of some short covering. Generally though, it feels as if the investor community is on edge, on tenterhooks, and anything that doesn’t fall into its nicely into its little place is a sign of impending disaster. There’s no middle ground, no sense of proportion. That’s what happens when it’s been too easy for too long. The ‘gimme’ trade is over. And because we have little real secondary market liquidity, any selling cares result in a disproportionate pricing action.

What’s normal anymore…? The above price action, thinking and skittishness has actually become the norm. It will take some getting used to, but it comes with being bailed out by the central banks, political interference in crisis leading to a poor regulatory response, and the ultimate resulting in the delay of the difficult decisions. For instance, the shock absorber which hitherto lessened the pain of any decent selling – the dealing desks – is no longer there to help lessen the blow in valuations when the market moves en masse in a particular direction. Less capital allocation afforded to that side of the business means that weaknesses will be exacerbated through valuations, as risk limits and positioning capabilities have been drastically reduced. It doesn’t help right now that we are also just a week away from quarter-end. Self (and performance) preservation has kicked in. Some upbeat headlines are needed – they might just save the day – otherwise expect a continued chipping away at prices with few likely going to step into the breach into month-end. Glorious October? Hmmm…

Calm returns, but it’s all very fragile… Rarely do we go up or down for a prolonged period in a straight line. Happily, Wednesday was the “let’s take a breather” day. And we did. European stocks were in the black, though into the close a weaker US market took the shine off the earlier, better intraday levels. In credit there was some price stability but hardly any recovery; the session ended leaving the broad measure of the corporate bond market – the IG iBoxx index – actually a basis point wider. Noise really given all we ave endured these past few sessions. VW paper found some stability (not necessarily a floor), its CDS level was barely improved though (5-year at 204bp, -7bp), but few were willing to step in given that tomorrow might bring another headline to take it all away again. The high yield market was also a little weaker and valuations here are beginning to look attractive. The new issue market was closed, with nothing on the screens in either financials or non-financials. This more stable session should not be seen as a turning point – far from it. We need a few more like it which also take in the VW situation and offer some further clarity on it. That, unfortunately, could be a long time coming.

On a housekeeping note, many thanks to you for your continuing support of this site.

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.