9th June 2020

HY Strategy: CMD Portfolio Performance Update 09/06/20

Market Overview

Global risk markets have been ripping higher. The huge liquidity injected into the financial system to help ease the pain of the economic downturn is looking for a home anticipating business as normal through H2. That’s before annual GDP growth shoots higher through the second leg of a V-shaped recovery in 2021.

The drivers are clear. All the data post-April is showing us that we are beginning to claw back lost growth, it’s going to be a long journey. Covid-19 transmission rates and associated deaths are declining. Lockdowns are easing. Economic recovery is picking-up albeit not quite bursting out of the starting blocks. That’s understandable.

Rates are lower for longer. The ECB/EU are adding more firepower to make sure there is no relapse and no deflation.

US equities (S&P) are now flat for the year to date and several good sessions away from their record level. European equities of late have joined the party, commodities haven’t done too badly and credit’s lure is undimmed.

We have a record run-rate in IG non-financial primary issuance, the bank AT1 market has re-opened with some massive investor interest and we can see the first signs of light emerging in high yield primary. S&P’s latest default comment has seen the agency give itself a wide berth as to what the default rate in Europe might peak at – a low of 3.5% and a high of 11.3%, but likely around the 8.5% mark.

High yield primary issuance

Spread markets are squeezing. The initial widening in spreads took us from an iBoxx index level 2020 tight of B+325bp in the middle of February to B+912bp at the peak of the weakness, on 23 March. The record wides came during the financial crisis when the index peaked at B+2200bp (although it was only a €50bn market then versus €350bn now). Spreads have since recovered around 70% of their coronavirus-related widening, with the HY iBoxx index now at B+483bp.

Admittedly, there has been little by way of secondary market activity, given that the obstacles to get a reasonable – or any – price in which to trade have been huge. Nor have we quite yet seen a blockbuster rise in defaults (that might come, see above), in no small part helped by the corporate funding disintermediation over the past 10-years which has seen the need for immediate funding pushed out to 2021 and beyond. Weaker bond covenants have also played a part.

High yield bond index

And we have high/low beta compression by the bucket load. The Markit iBoxx index spread between the HY and IG indices gapped from a little over 200bp at the beginning of the year to almost 650bp at the worst of the market’s reaction to the pandemic. Once the policy action got started and confidence returned, we have seen a crunch tighter in high yield spreads versus IG and that difference is now at around 350bp.

HY/IG spread compression

If the current trajectory continues and the background noise remains supportive, then a sub-300bp level on that compression is quite possible sometime in Q3.

Since we started our CreditMarketDaily.com sterling HY portfolio, around the middle of April, our holdings have recorded total returns in the two-month period of 8.2%. Against the iBoxx index, which has returned 6.7% (€ and £), it is outperforming.

Our holdings so far comprise NewDay, Saga, Iceland, TalkTalk and since our last update we added Shop Direct and few would argue that they are at the more high-yielding spectrum of the high yield market.

The markets are poised to continue to look past the bad news items which will come their way through the rest of June and July (at least). Much of the data is backward-looking although the current crop of reports suggests that we had a worse than expected April and May.

Still, as as we look at the expected dynamics of the recovery albeit amid the elevated levels of uncertainty that it includes, there is still much to play for. We will get over this bad patch. Nor would we underestimate the impact on markets from cheap and plentiful liquidity. By and large, it’s worked a treat since the financial crisis.

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.