28th September 2015

Canaries, coal mines, Volkswagen, opportunity

FTSE 100
6,109, +148
9,689, +261
S&P 500
1,931, -1
iTraxx Main
84.5bp, -1.5bp
iTraxx X-Over Index
348bp, -6bp
10 Yr Bund
iBoxx Corp IG
B+161bp, +1bp 
iBoxx Corp HY Index
B+518bp, +1bp
10 Yr US T-Bond

False start to the sales… A couple of weeks ago we suggested that once the Fed was done (our call was for no rise), the weakness we had seen in corporate bond spreads through August and September emanating from the uncertainty of it – as well as the huge levels of primary supply – represented a buying opportunity, and it would be time to go shopping. After all, with the Fed done and dusted until perhaps December, the rest of the unknowns were quantifiable. That is, we knew that China was/is a source of headline risk and volatility, that global growth is slowing, that Europe is failing to break out of its dual low/no growth/inflation dynamic and that geopolitics are as difficult as they have ever been. Hopefully, few heeded our message. Because the VW emissions scandal – which is still developing – has turned out to be the canary in the coal mine, and it has changed the picture completely. It’s like the sales are on, the doors have opened, but we’re waiting for the damaged stock to be put out at rock bottom prices before we get stuck in. In a way, investors are staying away until the bandwagon is in view – though usually by then it’s too late. We won’t catch the bottom, we might need to take some pain going in too early, but cheapening corporate bond prices in industries/areas not impacted by the VW story have to be worth a look at. That is, the contagion impact from the auto-emissions debacle is an opportunity – but timing is everything.

Month-end dynamics playing their part… Time will tell, but for now, as we near the end of September, we think monthly/quarterly dynamics are playing their part in investors’ willingness to take risk. There will be some sizeable hits to portfolios given the weakness, but other asset classes have fared worse. The big picture shows that IG corporate credit (iBoxx index) has lost 1.4% YTD and spreads have widened by 50bp. For the QTD, that’s +0.2% and +24bp respectively, while the monthly return sees losses of -0.2% and spreads wider by 21bp. These return numbers are no disaster when, say, put against the volatility of some equity indices. For comparison, the DAX is down almost 1% YTD, a whopping 13% QTD and 3% in the month so far. The numbers do hide some ills though. Benchmark players with a higher beta positioning (most of them) will be underperforming massively; auto positions will show severe weakness and the HY sector has been caught up in it, while doing little wrong. We’ve championed corporate bonds for years, believing that they have become a core asset class along with government bonds and equities, having exhibited exponential growth in volume in the crisis years. Their safe-haven status remains intact, though the bond market is not immune to event risk. I’m still with corporate bonds.

Some relief but no joy… The relief into last week’s slightly better close wasn’t of the ‘high-fiving’ sort and is likely a harbinger of how events might pan out this week and beyond. Equities in Europe might have got a fairly decent short covering-like bid behind them, but credit’s recovery was much more cautious. Interestingly, watching developments in the synthetic markets, while single names afflicted by the scandal and macro risks have gapped (VW, autos, Glencore, Anglo and so on), iTraxx index levels haven’t moved with the same voracity as equities. Not long ago, this level of equity volatility would have translated into much greater swings in the indices. Not now: pound-for-pound we’re seeing much-reduced volatility in the synthetic space.

Autos and basic resources lead credit weakness… So Friday’s picture was better but mixed, with hybrids lower on supply fears but VW’s hybrids bouncing a point or so; AT1/CoCo risk was priced higher on better equities by up to 75c and we saw other beaten-up paper marked better too, including LatAm risk. On the downside, Glencore and Anglo American took some punishment, with both some 50bp wider amid clear sellers, and little interest for the other side of the trade. The Swiss have temporarily banned the sale of VW cars impacted by the emissions tests, and we can expect more of this type of headline risk to keep VW spreads from staging any material recovery. Stay away. Overall it was a poor week for credit, with the iBoxx IG index out 10bp to B+161bp and the HY index at B+518bp (+33bp in the week). The two biggest losers were autos and basic resources, where the iBoxx sub-indices moved 55bp and 80bp wider in the week respectively. In primary, Campari’s deal got away, but the increased Eur600m deal was only 2x covered, priced with a 2.75% coupon for the unrated, HY implied-rated issuer.

On Sunday, the Catalan election saw the separatist “Junts Pel Si” group win an overall majority in Parliament which will now likely set off the process for  referendum (likely unofficial) on independence for the Catalonia region from Spain. More immediately, it’s going to stop the Bund-Bono spread from recovering. It’s up at 138bp in 10-years and the uncertainty that the election result brings will keep it elevated. Sub-100bp looks a tough ask at the moment. Elsewhere this week we have eurozone flash inflation numbers on Wednesday and September’s US non-farm payroll report to look forward to on Friday.

Have a good week.

Suki Mann

A 30+ 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 CreditMarketDaily.com.