16th December 2018

Don’t buy this dip

iTraxx Main

80.7bp, +1.2bp

iTraxx X-Over

334.1bp, +8.6bp

🇩🇪 10 Yr Bund

0.26%, -2bp

iBoxx Corp IG

B+170bp, unchanged 

iBoxx Corp HY

B+508bp, unchanged 

🇺🇸 10 Yr US T-Bond

2.89%, -2bp

🇬🇧 FTSE 100 [wp_live_scraper id=”17″], [wp_live_scraper id=”24″] 🇩🇪 DAX [wp_live_scraper id=”19″], [wp_live_scraper id=”25″] 🇺🇸 S&P 500 [wp_live_scraper id=”21″], [wp_live_scraper id=”26″]

Things might not get better…

It’s been the most difficult year and, having held on so well for so long, the credit market effectively capitulated in the final quarter. Spread widening accelerated, primary ground to a halt – we believe prematurely –  and total returns gapped lower through a difficult November and December as performance dropped sharply. 2018 is just about the worst recorded for credit since the 2008 crisis year. It looks bad (and it is), but there ought not to have been the sense of crisis for the asset class. Fear just seemed to creep in as equities tumbled and rates rallied, which then saw single names afflicted by any negative news flow gap wider in an unforgiving name specific sell-off. New deals thus needed to offer significant premiums to get away, secondary repricing was brutal leaving us to fear the next primary offering.

The rally last midweek was most welcome and was one that managed to reduce some of the weakness before it – in equities especially – but only temporarily. We had another difficult session on Friday to close the week (US stocks lost 2% on Friday). It was too late to save much in credit. Losses for the year in equities, though, not helped by Friday’s weakness – are dire. For example, the Dax has given up over 2,000 points this year – that’s over 16%. Credit only managed to slow its decline (spread weakness), but we are in ‘lock-down’ as borrowers are absent and secondary activity the sole preserve of what’s left of the ECB’s QE interests.

Some had hoped that we would see a thawing in Sino-US relations and a tariff agreement of sorts which would then provide a useful driver for a bounce in valuations has been supportive on occasions. But it faded quickly and was undone last week, for example, by Chinese growth fears (see below). There was, however, some perhaps longer lasting joy on the Italian government yielding to the EC’s demands that it redresses its budget deficit target lower, and BTP yields moved back below 3%.

Elsewhere, Theresa May might have survived her confidence vote, but that was about all she got and her position still looks as untenable as ever after a quite disastrous mercy dash to Brussels at the end of last week. She came back empty-handed, just like David Cameron before her. This story has much more to run over the Christmas period.

So the markets have sticking plaster all over them. The ruptures will persist through 2019 and are going to be elevated by macro weakness. It just doesn’t look great on macro. The Eurozone appears to be slipping into recession. French manufacturing PMI for November showed that the sector had slipped into contraction territory (at 49.7), not helped of course by the Gilets Jaunts protests – but high levels of weakness were there, anyway. More generally, the recent data sets from the Eurozone as a whole are pointing to a lower growth environment, one which the ECB attested to in last week’s meeting.

Downgrading growth forecasts the ECB might have done, but QE is still ending (before the job is done) and that rate hike pencilled in for September next year, well, looks like it isn’t coming. More policy accommodation might be necessary in our view. Importantly for the global economy, Chinese growth is flagging and while the German auto sector might benefit from the import tariff cuts (announced on Friday), it’s probably too late.

So we end the year with a deteriorating macro outlook. We’re none-the-wiser on PM May’s Brexit deal (will not pass a vote in the Commons). China might have cut auto tariff imports for three months starting January, but we’re going to be more distracted by the broader slowdown in their economy. The multitude of stimulus measures in place there are not working. The Eurozone’s slowdown is confirmed and a ‘no-deal’ Brexit will be a hammer blow for the region – and especially so if they play hardball in a pushback against the UK.

As things stand, we don’t see much reason to feel upbeat when we’re back in January. We would think that the market will start with a defensive tone to it. In credit, all eyes, as usual, will be on portfolio flows and the primary market. We reset the performance marker to zero, where moderate spread weakness will hopefully be offset by a relatively benign rates market and just manage to keep us in the black in total return terms.

Primary closes with a whimper

And that’s also it for the primary market this year. We are most unlikely going to get a deal which matters between now and January. December has only seen SAP’s €4.5bn, 5-tranche offering in IG non-financials. We didn’t even get close to a deal last week. In fact, as suggested above, investors are nervous about receiving a new deal, given the repricing effect it has on secondaries. Recent deals have come so cheap that curves have been battered and bruised, badly.

So we close 2018 with just €220.5bn of IG non-financial issuance. That compares unfavourably with the €265bn issued in 2017 (and similar levels in the 4-years before that). Given the weak macro outlook and other geopolitical situations still brewing and evolving, a volatile start (f nothing more) to 2019 will keep primary issuance under lock and key. That is, don’t expect January to be effusive enough as to deliver a €20bn-like month. We can’t see that right now.

The HY market looks like it will deliver its first zero December of issuance since before 2014, as well as the first zero month since at least the beginning of 2014. Mind, the €62bn of issuance is the second-best year on record, after the €75bn printed last year.

Likewise, senior financial issuance is a zero for December and we don’t expect anything to get done now. The sector isn’t exactly the flavour of the month. The last zero month was well before 2014. For the year, issuance of €130bn makes it the lowest level of supply in the euro currency era.

Don’t you be buying the dip

We closed last week with European stocks down by up to 0.9%, but there is going to be an element of catch up when we start business this week as the US markets had a torrid time of it after we closed in Europe. The S&P, for example, closed 2% lower at 2,599 and is almost 3% lower this year now. This index was riding high, up by 11% at the back end of Q3. The lesson of the past quarter is don’t buy the dip. Every time we have tried, the next drop has come quick and hard. The news flow was poor too, with J&J tarnished and its stock hammered after reports that the company knew for decades of asbestos in its baby powder.

While equities have grabbed most of the headlines, rates have sneakily dropped to close their lows for this year in Europe and the US is better bid at the moment, too. The Fed is up this week and is expected to raise interest rates by 25bp, although we will be watching for any clues as to next year’s interest rate intentions.

Bunds closed to yield 0.26% (-2bp) in the 10-year at the close and will possibly finish the year below a yield of 0.30% – and hold somewhere around these levels into Q1/2 2019. The news flow isn’t going to be pretty and we don’t see how this market won’t remain better bid for a while. Most were looking for 0.75% – 1% as a year-end target for 2018. We won’t be anywhere near that in 2019 even, most likely!

Brexit and general economic weakness/geopolitical nervousness will keep Gilts similarly anchored, the 10-year yield now at 1.25% versus 1.19% at the start of the year and a 2018 high of 1.72%. The call for 2019 is anyone’s guess, while this week’s BoE MPC meeting will yield very little.

Cash credit in investment grade closed unchanged but we think any enquiry from now will be met with a defensive Street. We’re going to edge wider, that is. The iBoxx cash index was left at B+170bp and managed to hold on to the partial recovery seen last midweek and was 6bp tighter in the week. Returns edged moderately higher, to -1.35% for the year to date. The much-maligned CoCo market was flattish in a quiet session, leaving the index just the wrong side of zero for the month in total returns but still off by 5% year to date.

The cash sterling market also held up relatively well, a little tighter in the week s a whole with total returns at -2% all helped by the better bid for the underlying. Euro high yield also closed unchanged, highlighting the lack of activity during that final session, with the index at B+508bp. Unfortunately, returns are at -3.2% although when set against equities, the high yield market has had a decent year.

With that, we’re closing out our analysis notes for this year – barring any noteworthy developments. 2018 has surprised us all and leaves us with much uncertainty as we head into 2019, which we think is going to be an exacting yet exciting period. All things being equal, my daily column will be back on January 2.

Wishing you a Merry Christmas and a happy and prosperous New Year 🎄

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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.