5th October 2015

Oops, it’s Monday again

FTSE 100
6,130, +58
9,553, +44
S&P 500
1,951, +28
iTraxx Main
91.5bp, -1.5bp
iTraxx X-Over Index
372bp, -11bp
10 Yr Bund
iBoxx Corp IG
B+170.4bp, +1bp 
iBoxx Corp HY Index
B+557bp, unch
10 Yr US T-Bond

The valuation’s wrong, it’s ridiculous… Oh no it isn’t. Glencore and Volkswagen debt is trading at junk risk levels, and the credit analyst community reports that this is unwarranted. Well, more so in the case of VW. The giant is too big to fail, has oodles of balance sheet cash, is still a profitable company, has a great product offering and once the brouhaha around the emissions scandal dies down will be funding in the public markets at give-away levels (to start with). What’s there not to like? Except that, for a fund manager, it’s never that simple. The market decides the price. Investor behaviour is to veer towards a positioning which protects performance. So when bonds are falling 2, 5 or even 10 points a session depending on the complex, few are willing to, wanting to, or going to look at the fundamentals. Liquidity and “what if” dominate the thinking – behavioural science comes into play. Specifically, in the case of VW, the group’s sustainable, superlative business (model) could be ravaged by untold fines. Investors have always hated uncertainty. Lest we forget that tap on the shoulder from the powers that be and the always dreaded “Why are you exposed to VW? Cut your position now.” The case for Glencore, to be frank, is even more difficult. Reports over the weekend suggest the company might be up for sale.The shorter end for Glencore yields 10-11%, the medium maturities 7-9% and the euro average single-B yield is roughly 6%. Overcooked?

We fear them, but here’s hoping… Apart from poor performance, the fear for most corporate bond fund managers is outflows. We continue to believe that one can still hide behind the “what else are you going to do?” technical of where to put any money – apart from keep it in cash. Certainly that is the case in the euro-denominated corporate bond market. But as we wrote last week, a market bereft of liquidity will be an unforgiving place to be if outflows do emerge, and so the defensive stance (higher cash positions being built) will be the trade for choice until stability and confidence return. Unfortunately, that means there will be no ratchet tighter in spread markets and new issue activity might be more subdued than usual, leaving overall activity much reduced.

NFP leaves much uncertainty… The weaker-than-expected non-farms print on Friday has again set the proverbial cat amongst the pigeons. That was a nasty NFP number and there is a zero interest-rate policy already: what can governments do about it?  It means lower rates for longer – no rate hike in October, and likely not in December. It means lower Treasury yields, lower Bund yields and all and sundry scratching their heads as to why the unemployment rate was at just 5.1%, yet there is no growth in hourly earnings and scant sign of inflation in the economy. Usually, stocks would be flying on the sure-fire prospect of easier money for a while yet. But while growth fears are on the up, it means lower earnings (unless corporates can continue to squeeze costs), investment remaining subdued and a close eye kept on capex budgets.

Credit could be back in fashion… It’s a funny old game. Equities neither hither nor thither on the prospects of lower growth, with the US seemingly unlikely to pull the world higher in its slipstream. Govvies bid up on flight-to-safety flows, leaving new money wondering where to go for a bit of safety and yield. Well, we still have a low corporate bond default rate. The ability for corporates to service their obligations is still the best it has ever been. The capital markets will be open for borrowers at still excellent historical funding levels should they wish to hoard more cash. Admittedly, the market has been scarred by the VW situation, and the price action around Glencore/commodity players has been a reason not to get involved. But there are plenty of boring, uneventful bonds available where one can clip a decent coupon, be assured of getting one’s money back at maturity and generate decent income. You can take as much or little risk as you like, but staying away from the ‘go-go’ situations will make for a easier existence. Boring has always been good in corporate bonds.

Volatile and unconvincing… Last week closed out in positive territory for stocks after a choppy Friday with that payroll giving everyone food for thought. Treasury and Bund yields fell, and credit endured a quiet but defensive session. That means it was weaker for choice. Spreads were inching wider overall, with hybrids and CoCos a tad weaker in price terms and few willing to get involved because not wanting to be exposed over the weekend. VW hybrids were up to 0.75 points lower in price. The iBoxx IG corporate index closed at B+170.4bp – almost a basis point wider in the session – with the HY index unchanged at B+557bp. In the synthetics arena, the iTraxx indices recovered a little (better offered) into those higher equities, and closed at 91.5bp for Main and 372bp for X-Over. The S&P closed 1.4% higher.

Spain was upgraded to BBB+ from BBB by S&P. And Alcoa kicks-off the third quarter earnings season after the closing bell on Thursday. Wishing you all a pleasant 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.