18th January 2016

The fat lady is singing

FTSE 100
5,804, -114
9,545, -249
S&P 500
1,880, -42
iTraxx Main
96bp, +5bp
iTraxx X-Over Index
385bp, +21bp
10 Yr Bund
iBoxx Corp Index
B+172.7bp, +3.5bp 
iBoxx Corp HY Index
B+585bp, +12.5bp
10 Yr US T-Bond

And it’s looking like it’s over… This is the first time we have ever said that. It does not look very bright at the moment, and we are in full flow heading lower now, it appears. The brakes are off and the slide looks ominous. Oil per barrel has breached $30 and while it might roll over for a refill at $25, it is heading towards $20: that lower level is increasingly becoming the will of the market, especially now that Iranian oil is back in the fold. The resulting sentiment is going to stay bearish and will see stocks remain under pressure. We ended the second week of the year badly. The US consumer spent less than expected in December, and producer prices also declined in the month. So inflation expectations will be tempered further, and the market reacted to the data by taking the 10-year UST yield to below 2.00%. Four anticipated rate rises this year must now be an impossibility – we would think that even two are looking out of reach right now. Sector risks are weighing on us as well, with commodities again looking to get routed. On Friday it was BHP’s turn, and the contagion impact on the rest of the sector was clear as it wrote down the value of its shale gas assets. The DAX is down double-digit percentages year-to-date (that’s in just two weeks); government bond yields are plummeting as flight to safety and capital preservation strategies kick in; and credit spreads are going significantly wider now, although perversely there is still considerable demand for corporate bonds – though only through primary. Issuers won’t bring deals though, as syndicates don’t want them to fail, while issuers don’t want to pay up, nor do they need the funding desperately – for the moment. Poorer secondary flows and volumes everywhere are light but clearly towards better selling, resulting in exacerbated price movements as the Street steps back and no one else – quite understandably – is prepared to step in. The fear now is that any attempt to recover will be met by investors looking to de-risk. It’s not quite the welcome to 2016 anyone envisaged. The great sword of Damocles? The thread has probably been cut.

And all this, absent a systemic crisis… But it might materialise into one: just look at the numbers. WTI managed to hold above $29 on Friday but dropped 5.7% in the session, while Brent fell 6.2% to close below $29. Brent, for example, has fallen by 25% already in 2016! Equities have equally been trounced. The DAX is 11% lower YTD, with the FTSE, S&P and Dow down around 8% and the NASDAQ off 10.5%. And in credit, the corporate bond market is the best of a bad bunch. As measured by the Markit iBoxx corporate bond IG index, spreads are now up at B+172.7bp or +18bp YTD, though returns are only showing a loss of 0.3%. In the high yield index, spreads have moved 57bp wider YTD, with 12.5bp of that coming in last Friday’s session. The index yield has risen to 5.8%. Returns for the asset class are showing a deficit of just 1.8%. A recovery – if it comes – will see to it that equities exhibit all the upside versus credit, highlighting how a diversified positioning in corporate bonds has been a fairly defensive trade. The iTraxx indices are currently at their contract wides of 96bp and 385bp for Main and X-Over respectively. If we do see a rally of any sort in stocks, the synthetic credit indices will crunch lower.

Even looking at it objectively, as we always do… there are no winners, and while we advocate sitting tight and letting the current malaise play out (credit has its upside – capital returned and some income, although mark-to-market losses will make for uncomfortable viewing), some investors will look to minimise the potential for further losses and try to sell. We can look at the fundamentals of the corporate bond market and even its relative attractiveness against other asset classes and make a case for it: just look at the aforementioned returns. But in the eye of this storm, that comfort offers little consolation. If indeed equities are going materially lower, if commodities are going to see a further rout, if corporate earnings are experiencing a secular decline, then capital preservation strategies win out. Cash under the mattress works, given that deposit rates would stay close to zero or go negative. But also, good, solid, quality corporate bonds might well be the pick of the bunch. However, we can understand that after surveying the damage to investments and portfolios, many might look to take their losses and move on (where to?). And in reality, only a few will need to do that for us to continue to experience weakness in spread markets, such is the dire situation around secondary market liquidity. Sit tight and ride it out if you can.

And finally, it looks like it will be a another difficult start to the week following 4-7% declines on Sunday across Middle Eastern stock markets. This comes on the back of the lifting of international sanctions against Iran and the prospect of 500,000+ barrels per day of Iranian crude coming on line soon. Once again, the (declining) oil price will dictate the pricing direction of most other risk assets. Keep watching. Back Tuesday.

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.