8th January 2016

The King was born

FTSE 100
5,594, +119
9,980, -234
S&P 500
1,943, -47
iTraxx Main
83bp, +1bp
iTraxx X-Over Index
343bp, +10bp
10 Yr Bund
iBoxx Corp IG
B+159.5bp, +2.5bp 
iBoxx Corp HY Index
B+544bp, +10bp
10 Yr US T-Bond

They put the wrong circuit breakers in… Another day, another 7% in China. Another “managed” currency depreciation too. And another fuse blown. Markets sold off, and the week threatens to be the worst start to a New Year since the early 1930s. Capital preservation strategies, if they were in place, are winning out versus more aggressive appreciation trades. For those involved in the corporate bond market, the 7-year long crisis and of course the current macro ills are by default seeing to it that investment in European corporates is a defensive strategy (and we include the better end of the European HY space in that). Small mercies, but at least we have only just small negative returns YTD. Corporate credit is currently the best of a bad bunch! Global equities this week have been pummelled on Chinese macro/stock jitters. Oil prices per barrel have been routed and they will soon be trading with a 2 handle. That means the feed through into the inflation numbers will continue, and that means more disinflationary pressures. The ECB will be readying its QE shopping trolley, and government bond yields will continue to fall (this trade works even if we backed up a little on Thursday). For corporate bonds, cash spreads are wider, but flow and volumes are close on nil. Nevertheless, in Europe the corporate sector is chugging along into whatever economic activity we have, the current malaise ensuring that cash-rich corporates will just maintain those defensive investments and balance sheet strategies that have served them well since 2008. At 9,980, the DAX index is around 850 points down on where it closed in 2015. That’s an eye-watering 7%, while other European indices are in the 4-6% down range. We will have the Q4 earnings season soon enough, and while the numbers might not be a catastrophe, we would think that the guidance and outlooks will be cautious – and that feeds into sentiment and investment/capex. It is looking like we are breaking with tradition and are set up for a difficult Q1. Let’s hope we are wrong.

It can still end well… if Fed members (remember them?), post-payroll today, offer soothing words about rates, paying attention to the fright global markets are taking on China. If the corporate earnings season is relatively good for Q4 (we mean generally beats lowered expectations) and some hope is offered that the New Year hasn’t been totally blighted by the risk-off nature of financial markets. If, also, the Chinese find a circuit breaker that works. If not, do away with them altogether – and this is finally what they have decided to do. Let the market fall, find its feet and a new level and then we can trade off that new, lower level. Because even though Chinese stocks have been dropping 7% a pop, and the Yuan was depreciated accordingly, it really did feel like a touch of the proverbial Chinese water torture treatment. All being told, there are still is a few big ‘ifs’ in there and it’s probably a big ask. Oh well, maybe it won’t end well after all.

We had warned on emerging markets… We offered that sentiment back in the first note of the year. The Chinese situation will lead to competitive devaluations and the industrial production print out of Brazil yesterday illustrates how that particular country is on the verge of, if not already undergoing, economic collapse. With global growth slowing and trade dropping, there seems to be little possibility for many EM economies to grow their way out of trouble. Default rates will pick up as dollar-funded corporates feel the heat of weaker domestic currencies (versus the dollar) while their top line growth also falls. Hitherto supportive credit metrics will deteriorate rather rapidly. Sovereign and corporate rating downgrades are coming, default rates are going to increase, confidence in these countries will not recover and staying well clear of them is the best policy. There are plenty of cheap assets around in corporate bonds, such as good single-A and double-A US-domiciled corporates, which issued in euros en masse in 2015 and whose bonds are now trading at relatively depressed levels. We admit they are trading cheap, and that they came cheap and generally widened, so they are not quite a “gimme” given that in Europe name recognition and nationality still matter. Still, go take a look.

Mini relief rally, holding breath for Friday… At this point we are inclined to think the authorities have done more good than bad with the removal of the stock market circuit breaker mechanism. Friday could be short covering day, before Monday’s sell-off. who knows? Some corners of the market certainly felt the same, and we ended the session in some quarters (European equities) on Thursday off the lows with a mini rally once the news broke. Oil prices actually firmed then gave way again. $33 per barrel is how we closed out (-1.4% to -2%). In corporate bonds (remember them?), the Markit iBoxx index closed at B+159.5bp (+2.5bp) and the HY index at B+544bp (+10bp). Surprisingly, the iTrax indices didn’t fall out of bed, with Main up a touch at 83bp and X-over at 343bp (+10bp).

Hopes for Friday? The S&P500 closed 47 points lower or, -2.37%. The Dow lost 392 points, or -2.32% and that usually means weakness in Europe on the follow. However, we can hope that the lack of a circuit breaker in Chinese stocks allow the electricity to flow, with little pain. That we have a bounce in a short covering end of week session and that we can relax over the weekend. Monday might be a more interesting day!

Thankyouverymuch, back Monday.

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.