30th September 2015

Red letter day

FTSE 100
5,909, -50
9,450, -33
S&P 500
1,884, +2
iTraxx Main
92bp, +1bp
iTraxx X-Over Index
383bp, +8bp
10 Yr Bund
iBoxx Corp IG
B+172bp, +6bp 
iBoxx Corp HY Index
B+552bp, +16bp
10 Yr US T-Bond

Time to take stock… It’s a sorry picture for risk assets. US rate risk, China’s economic slowdown and VW’s burnout all saw to it that September has been the cruellest of months. It’s not the worst year credit has seen, despite protestations and comments elsewhere to the contrary. In 2008, for example, credit lost 5%. Nevertheless, investment-grade corporate bonds have given up 2% YTD (iBoxx) and 0.75% in September in absolute terms. For the benchmark players, spreads are 61bp wider YTD and an eye-watering 32bp wider in the month alone on the index. It’s worse than that for most though, given the higher beta positioning many investors have, leading to underperformance versus the benchmark as a result. Non-financials are returning -2.3% YTD and financials -1.2%, as we might expect. The beaten-up sectors are autos and basic resources, and the product most under fire has been corporate hybrids, given that VW makes up much of the index, having over Eur7bn of them outstanding. Still, we do not anticipate much by way of outflows from IG funds. The HY sector was in great form – until last week. Returns YTD now come in at -1%, but all of that has been lost in the last few days of September. For the month, HY returns as shown by the iBoxx index are at -2.75%; outflows will surely follow into October. Spreads have gapped 94bp in September and 117bp for the year thus far. And it is the weakness in HY spreads which has contributed to the poor performance, because the shorter duration nature of the HY market has seen to it that the anchoring of the front-end of the underlying has helped to keep that side of the performance contribution well-supported. It’s worth noting that sterling credit has done very well in comparison. Spreads are only 30bp wider YTD but returns in the same period are at -0.7%, while for the month sterling corporate bonds returns are flat (with Gilts at +1.4% YTD). Sterling by name, rock solid by…

It’s bad for corporate bonds, but worse for equities… The DAX is down around 2.5% YTD, but that hides many ills. It was up 25% YTD in mid-April. We could go on, with EuroStoxx50, the FTSE and the CAC. You get the picture. We have said for years that this crisis which began in 2008 was about preserving capital. Thats why corporate bonds have been – and we believe still are – worth their weight in gold. There will be a time to bailout, it’s just not yet. We wouldn’t be putting a capital appreciation strategy in place (buy equities, sell credit) until we are sure that we have a sustainable growth dynamic. That could still be a long time coming. And when it does come, if the growth path and trajectory suggest the rise will be rapid, then corporate bonds will come under huge pressure as sellers seek non-existent buyers. What we have witnessed in September will be a walk in the park in comparison. And that will come while the economy is improving! Who said the markets were being manipulated? Anyway, don’t fret. It isn’t going to happen anytime soon. On the bright side, ECB QE and the potential for more to come has seen to it that despite the mid-year sell-off, sovereign debt has performed well. Eurozone sovereigns have returned around 1.5% in September and 0.7% YTD.

Fixed income still works… Overall, fixed income markets are still holding out. Returns everywhere are poor/falling, but with a low default rate, capital preservation has been the modus operandi of the investment process and we believe should stay that way. If it was just China and the Fed, our market (corporate credit) would have been in much better shape. Alas, the VW-type of event risk is something no one can position for. The global picture is as uncertain as it ever was, visibility on macro as poor as ever and the requirement has to be to stay defensive. So we do not expect any material outflows from the asset class, except for some HY funds that might come under pressure because outflows are dependent on monthly returns. That’s just the nature of the beast.

Tired into month-end… As we could have expected, the penultimate session was on the defensive, and even bit of a bounce was observed in some quarters as the likes of Glencore fought back. Well, their stock did on the back of some upbeat broker comment, bouncing 17%. Equities traded blows between red and black, and in a tight range for much of the session. VW’s stock was a small down. Germany inflation came in at a negative 0.2% and points to a low/zero-like figure for the flash eurozone figure out later today (Wednesday). In credit, most of the activity was around squaring up positions into month-end, sorting portfolio valuations (see above) and doubtless many a meeting to discuss strategy and positioning for the final quarter. Specifically, Glencore paper moved a little higher (in price) amid small buying interests, VW was rangebound amid two-way flows and the rest was simply weaker. Overall, little conviction anywhere. Weakness in Asia markets saw to it that the much exposed Standard Chartered was seeing much action, its 10NC5 LT2 now at around B+500bp (+50bp).

The iBoxx index closed at B+172bp for IG (+6bp), and B+552bp (+16bp) in HY. All very weak. The iTraxx indices followed stocks, just marginally weaker. Wednesday sees flash inflation numbers for the eurozone, and no doubt much more will follow on the need for expanding the size and scope of the current QE programme by the ECB. KFW issued a three year zero coupon deal for Eur5bn, allowing some to park cash for no (limited) cost.

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.