In High Yield, Expect Volatility, Not Crisis

  |   For  |  0 Comentarios

En high yield esperamos volatilidad, no crisis
CC-BY-SA-2.0, FlickrPhoto: Atli Hardarson. In High Yield, Expect Volatility, Not Crisis

We’ve been hearing a lot lately from people who fear that rising interest rates may cause a crisis in US high yield. In our view, the logic doesn’t add up.

Don’t get us wrong: we understand why some investors are anxious. After all, it’s been almost a decade since the Federal Reserve last raised rates, and these many years of cheap credit conditions have left high yield looking a bit pricey. As we’ve written before, that’s certainly a reason to be selective. But it’s no reason to retreat from high yield altogether.

So what exactly are people worried about?

The hypothetical scenario goes something like this: Over the next year or two, rising rates will make it hard for high-yield companies to roll over their debt when their bonds mature, causing many to default. That could provoke a sell-off, and the less liquid conditions that make it harder to buy and sell bonds could turn into a full-fledged crisis.

Standing Tall as Rates Rise

There’s a lot to unpack there. First, let’s address default risk. This is something investors must always keep an eye on, and nobody should disregard it because current default rates remain low.

But here’s the thing: Rising interest rates don’t necessarily mean defaults will spike. In fact, high yield has weathered rising rate environments well. Since 1998 there have been four calendar years in which the Fed lifted policy rates, and high yield posted a positive return in all of them (Display).
 


Ampliar

That’s largely because rising rates go hand in hand with an improving economy. And in a growing economy, companies’ business prospects and credit standing improve, causing the extra yield offered by high-yield bonds versus US Treasuries—the yield spread—to shrink. This scenario works in favor of high-yield prices.

Different Bonds, Different Risks

Will the default rate rise as rates move higher? Of course. That’s inevitable when the credit cycle moves from expansion to contraction. Over the next few years, we expect the default rate to drift back toward its long-term average—about 3.8%, according to J.P. Morgan—from a bit less than 2.0% last year.

Moreover, not every high-yield company faces the same risk. We worry about issuers with fragile balance sheets and high debt levels. Many CCC-rated junk bonds fall into this category.

For companies with sound finances—including many BB- and B-rated high-yield issuers—rising rates are less of a concern. And remember—Fed policymakers have been pretty clear about their intention to push up rates slowly. Some market participants now say they don’t expect the first hike until 2016. That doesn’t strike us as a frightening scenario for high yield.

We think it’s also helpful to keep in mind that high-yield bonds, like most other bonds, have a known ending value. As long as the issuer doesn’t go bankrupt, investors get their money back when the bond matures. A period of rising rates may sometimes make total return lower than it would otherwise have been. But it doesn’t mean bond investors have to lose money. They may even come out ahead.

Liquidity Risk Can Be Managed

What about liquidity? There’s no doubt there’s less of it in today’s fixed-income markets. But this isn’t a new phenomenon. Corporate bond markets in general—and high yield in particular—were never as liquid as US Treasuries. And new bank regulations that have been draining even more liquidity from the market have been on our radar for years.

But as we’ve pointed out before, illiquid markets can offer attractive opportunities. When liquidity dries up in one sector, it can be plentiful in another. If managed properly, it can be an additional source of return.

US high-yield companies are by and large in the later stages of the credit cycle. But we don’t think investors should be winding down their high-yield allocations. Interest rates overall will remain low even after the Fed starts tightening policy. At average yields of nearly 6%, high-yield bonds offer investors who do their credit analysis a reasonable opportunity to potentially boost returns.

Should you expect periodic bouts of volatility in the coming year or two as Fed rate hikes become a reality? Absolutely. But a crisis? We don’t think so.

Opinion column by Gershon M. Distenfeld, CFA, Head of High-Yield Debt Securities across dedicated and multisector fixed-income portfolios for AllianceBernstein.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

Higher Government Yields Suggest Choppier Waters for Credit Markets in the Short Term

  |   For  |  0 Comentarios

Los mercados de crédito navegarán en aguas turbulentas a corto plazo
CC-BY-SA-2.0, FlickrPhoto: Mike Beauregard. Higher Government Yields Suggest Choppier Waters for Credit Markets in the Short Term

There is an old adage in stock markets which suggests that investors should ‘sell in May, go away, and don’t come back until St Leger’s Day’. While we would never advocate such a simplistic strategy in an era of interdependent and interconnected financial markets, some investors will undoubtedly wish that they had sold and gone away given the weakness that is now being seen in bond markets. Since the beginning of April, the yield on the benchmark 10-year US Treasury has climbed from 1.86% to around 2.25%-2,27%.

While credit markets have ridden out the storm so far, longer-duration assets such as investment-grade credit are bound to come under some pressure if core bond yields continue to rise at the rate seen recently. The point at which core bond yields become attractive again is still some way off in our view. Nonetheless, the weakness in bond markets will certainly provide income-seeking and ‘go anywhere’ investors with plenty of food for thought.

For equities, the rise in bond yields is something of a double-edged sword. On the one hand, rising yields imply a stronger economic growth outlook and a return to normality following a period of very low or even negative bond yields. On the other hand, a prolonged and sustained rise in bond yields means that risk-free discount rates are likely to rise, which is unhelpful for equities, as the value of future earnings and profits is calculated by using a risk-free rate. Given that equity market returns in recent years have been driven by a valuation re-rating and the abundant liquidity provided by QE, rather than by earnings growth, a bond market sell-off could prove to be unsettling for stocks.

As we have discussed in our recent updates, we remain overweight equities in our asset allocation portfolios but have been taking a little money out of equities as a risk-reduction measure. Within equities, we continue to overweight Japan, the UK, Europe excluding the UK and Asia excluding Japan, while we remain underweight US and emerging market equities. In fixed income, we believe that the additional yield pick up from investment grade over government bonds – around 130bps for high-quality US investment grade – will provide support for the asset class given the lack of obvious alternatives, particularly for investors who can only invest in fixed income. Nonetheless, higher government yields suggest choppier waters for credit markets in the short term. We will be monitoring developments closely and we are running a short duration stance in our retail credit portfolios.

Our overweight in UK equities has worked well in recent weeks as the FTSE has rallied to within touching distance of its all-time high following a surprise general election result that saw the Conservative Party secure an outright, albeit small, majority. Scotland, meanwhile, is now in effect a one-party state with the SNP controlling 56 of the 59 Scottish seats at Westminster. In the coming weeks and months, the noise around further devolution and federalism is likely to increase, and further out on the horizon is a promised referendum on EU membership in 2017. In the short term, markets have clearly liked the election result and sterling has also rallied, but the longer-term outlook for the UK’s role in Europe is perhaps more uncertain now than at any time since the mid-1970s.

Mark Burgess is CIO EMEA and Global Head of Equities at Columbia Threadneedle Investments.

 

China is Choking on its Own Debt

  |   For  |  0 Comentarios

China se está ahogando en su propia deuda
CC-BY-SA-2.0, FlickrPhoto: IQRemix. China is Choking on its Own Debt

China is Choking on its Own Debt. We have it on good authority. And in this case that authority is an unlikely source – the People’s Bank of China (PBoC). It’s difficult to remember the last time so many paid so little attention to something so vitally important. The revelation came in the bank’s release of its 1Q 2015 Monetary Policy Report on 8 May 2015.

The catch? The report is available only in a Chinese language version. In the report, the PBoC acknowledges:

  1. China has too much debt
  2. The government has relied too heavily on investment for growth
  3. Credit expansion is no longer possible
  4. The economy is inevitably decelerating as a result

These conclusions are not new for most of us, but the government’s admission of the problem is very new and very important. The English version of the quarterly monetary reports is usually published with a two months’ lag. So we are unlikely to see the English translation of this first quarter report until early July 2015.

Why is this important?

The PBoC has explicitly acknowledged that leverage in China is excessive and the level of debt is an impediment to further growth. We have been relating this story for months (maybe years), but now the government has openly acknowledged it’s in a bind. Here’s the relevant excerpt in the translation provided in the Bloomberg story.

“…Economic growth is, to a large extent, still relying on government-led investment, and the room for further expansion is quite limited. In addition, the rising debt size is forcing China to use a lot of resources in repaying and rolling over debt, which leads to contraction effects for the macro economy.”

Given the exceptional nature of the disclosure, we were determined to corroborate its validity. With Google translate in hand, we scanned the PBoC website and found our way to page 54 of the monetary report in Mandarin.

“Mostly Mandarin” website policy leaves foreigners out of the loop

The PBoC web site in English is far from exemplary in its disclosure. In fact, I find the differences between the PBoC’s English language and Chinese language sites utterly surprising from a country that aspires to an equal footing in the international community. If China aspires to have a reserve currency, shouldn’t transparency in monetary policy be a top priority for the PBoC?  

I spent some time comparing the two sites and quickly made the following observations: the news scroll on the Chinese site posted 32 stories during April 2015, while the English site posted only 12. If you’re looking for detailed statistics, the English website will only bring you up into the current decade with 2010 information. On the other hand, the Chinese website appears to be full-fledged and current. Chinese economic data are available elsewhere, but in many cases entirely behind pay walls (Bloomberg, Haver and the CEIC data base.)

We ask ourselves the obvious question…is a currency with such a chasm in information disparities ready for an open current account? I think not.

Joseph Taylor is a vice president of Loomis, Sayles & Company and senior sovereign analyst for the Loomis Sayles fixed income group.

European Equities: After the Bond Fall

  |   For  |  0 Comentarios

Renta variable europea: tras la caída de la renta fija
CC-BY-SA-2.0, FlickrPhoto: Blu News. European Equities: After the Bond Fall

The recent sharp fall in bond prices, which saw yields on German bunds climb to a six-month high of 0.72% on 13 May 2015, caused a long-anticipated consolidation in European equities. It also helped the euro to strengthen, stopping the US dollar rally in its tracks, in spite of continued nervousness over Greece.

Along with these moves, the oil price rallied and many stocks that outperformed during the first part of the year went into reverse. This triggered warnings that the equity rally may be over. I disagree: I think this has been a necessary breather, before we see a continuation of better economic and profits news over the next few months.

The return of pricing power

There are signs that inflation is picking up. European Central Bank (ECB) President, Mario Draghi, flagged up at the ECB Governing Council meeting on 15 April that inflation rates are expected to “increase later in 2015 and to pick up further during 2016 and 2017”. This is good news for equities – suggesting a return of pricing power. It is also positive for economies, because a moderate level of inflation is probably the most palatable way to begin eroding the vast amount of government debt built up globally over the past 25 years or so.

Inflation is, however, not good news for those who, spurred by deflationary fears, bought any of the high number of bonds that have started to trade on negative yields. These so-called “crowded trades” (where a position, whether short or long, is held by a large number of investors) look fine until there is a stampede for the exit. So perhaps there has been an element of this in recent moves.

Economic indicators remain supportive

For the medium and long-term investor it is perhaps more important to look beyond short-term trading noise and consider whether the gradual improvement in economies will continue. Recent data shows that European economies are getting better, albeit slowly, and an expected interest rate hike in the US may be postponed due to the country’s weak start to this year, impacted by port strikes and bad weather. This should reassure investors that US monetary policy is likely to remain accommodative.

It is clear, however, that European markets have moved on. The MSCI Europe Index 12-month forward price/earnings (P/E) ratio is close to 16x earnings – higher than average, but not necessarily a cause for concern as long as P/Es in the US remain higher. Furthermore, European companies are at the start of a period of recovery for profits. Even if inflation reaches 2% in the coming years, if the “rule of 20” (a view that the stock market is correctly valued when the average P/E plus the rate of inflation equals 20) holds true, European markets can become more expensive in terms of P/E ratios. From a dividend perspective, yields on European equities also remain well ahead of those on German 10-year government bonds (3.1% average for the MSCI Europe Index, as at 30 April 2015, versus 0.6% for bunds, as at 15 May 2015).

European politics: certainty and uncertainty

On the political side, the election of a Conservative government in the UK maintains the status quo. There is a risk that the new government could be pulled towards the Right by those members with an anti-Europe, anti-welfare mandate, but my suspicion is that David Cameron and his allies know that UK elections are won and lost in the middle ground. There is a possibility that the “in/out” referendum on Europe, scheduled for 2017, could go the wrong way for markets (i.e. the UK decides to leave Europe), but my view remains that the UK is better off in a properly functional European Union. I also accept, as do most European leaders, that Europe needs to undertake further serious – and successful – reforms.

Greece, as always, remains a problem. The impasse between Prime Minister Alexis Tsipras, who refuses to accept the need for fundamental reforms, and the International Monetary Fund and ECB, who have refused to provide further financial support until reforms begin, looks set to continue. If Greece wants to stay in the euro, it must adopt reforms and prove that it is heading in the right direction, as far as budget stability is concerned. Sadly, the current Greek government has reversed the progress made by previous administrations, making the situation even worse for the long-suffering Greek people.

The European story continues

Putting it all together, recent signs of strength in European economies, coincident with weaker-than-expected growth in China and the US, have led to a logical shift in sentiment. Further good news should be still to come from European equities, including an increase in merger and acquisition activity, while the ECB continues to press ahead with its monetary stimulus programme. Furthermore, the current trend, whereby money is flowing from bonds into equities, should continue. This is hardly surprising given the different expectations for each asset class over the next 12 to 18 months.

In my view it is too early to be scared about a return to a slightly more normal economic environment. But we remain wary of the “crowded trade” effect, which is likely to fuel bouts of higher market volatility from time to time.

Tim Stevenson is manager of the Henderson Horizon Pan European Equity Fund at Henderson GI.

Taking Advantage of Volatility to Reinforce Eurozone Equities

  |   For  |  0 Comentarios

Aprovechando la volatilidad para reforzar la renta variable de la zona euro
CC-BY-SA-2.0, FlickrPhoto: Tuscasasrurales. Taking Advantage of Volatility to Reinforce Eurozone Equities

The economic environment continues to soften in the US and investors are starting to have doubts on the momentum of the global recovery’s main driver. There is no doubt that the weakness in the US economy is due to more than simply technical factors like the cold spell at the beginning of 2015 and strikes in oil terminals but we still think it is only temporary.

The slump in oil prices at the end of 2014 triggered drastic cuts to investment in the energy sector while households mostly reacted to lower oil prices by boosting savings rather than spending. Brutal oil price shifts in the past have always had an effect over several quarters and not a few weeks. Consequently, after initially suffering from the negative impact of lower oil prices, we should now start to benefit from them. Our economic scenario is unchanged: the US recovery is proceeding and will drive Europe and Japan while Europe’s return to normal is taking place in better conditions.

We can no longer bank on multiple expansion on today’s equity markets so we prefer markets where earnings growth looks most likely to generate the most positive surprises.

Our convictions on equity markets:

In this respect, euro equity markets have been more turbulent in recent weeks, most probably due to fresh uncertainty in Greece but essentially because of the euro’s violent rebound. True, the Greek issue is by no means settled but we believe the talks have taken a more positive turn since Athens reshuffled the team that is negotiating with the Troika. The government’s falling popularity and recent opinions polls which suggest the Greeks are still just as attached to the Eurozone seem to have prompted a political inflection. This will, however, need to be confirmed in coming weeks. The referendum planned by the Tsipras administration over reforms agreed with the Troika could still be very risky. But it would appear that it might get popular support and thus end a period of intense political confusion.

Elsewhere, the euro’s rebound looks largely technical, a case of markets taking a breather after a brutal correction. We see no lasting bounce in the euro and remain bullish of the US dollar. Meanwhile, there are encouraging signs that Italy is emerging from a long crisis, probably due to reforms introduced over the last two years. And lastly, we have seen encouraging results from European companies to date, enough to justify expectations of strong earnings growth in 2015.

For all these reasons, we have been taking advantage of market falls to reinforce our overweight position on Eurozone equities, moving from =/+ to +.

Our convictions on bonds markets:

We have also cut our rating on Eurozone debt on the grounds that all government bonds are expensive compared to other asset classes.

10-year German bonds offer almost no yield and there seems to be little scope for spreads on peripheral debt to narrow. Expected returns are therefore very low. At the same time, such low yields will make it increasingly difficult for Eurozone bonds to act as efficient protection should risk aversion increase. In bond portfolios, government bonds are still important but in our diversified portfolios we can afford to take profits.

Column by EdRAM. Benjamin Melman is Head of Asset Allocation and Sovereign Debt in Edmond de Rothschild Asset Management (France).

Disclaimer: This document is for information only.The data, comments and analysis in this document reflect the opinion of Edmond de Rothschild Asset Management (France) and its affiliates with respect to the markets, their trends, regulation and tax issues, on the basis of its own expertise, economic analysis and information currently known to it. However, they shall not under any circumstances be construed as comprising any sort of undertaking or guarantee whatsoever on the part of Edmond de Rothschild Asset Management (France). Any investment involves specific risks. Main investment risks: risk of capital loss, equity risk, credit risk and fixed income risk. Any investment involves specific risks. All potential investors must take prior measures and specialist advice in order to analyse the risks and establish his or her own opinion independent of Edmondde Rothschild Asset Management (France) in order to determine the relevance of such an investment to his or her own financial situation.

Change of Trends Between Europe and US?

  |   For  |  0 Comentarios

¿Intercambio de tendencias entre EE.UU. y Europa?
CC-BY-SA-2.0, FlickrPhoto: Lauren Manning. Change of Trends Between Europe and US?

In Europe, economic data published since the start of the year has confirmed our view that economic recovery is taking place. We are confident that activity will accelerate further this year as there are several sources of growth. In the main Eurozone economies (Germany, France, Spain and Italy) which represent about ¾ of the region-wide GDP, exports are growing at a robust pace. Reforms implemented and the weaknesses of the single currency have all contributed to improve the competitiveness of these countries. More important in our view, domestic demand which was the major drag on growth is bottoming out. In all the main Eurozone economies, consumption is expanding on the back of a slightly better employment outlook and rising consumer confidence. Regarding investments, the GDP is by far the component the most hit by the crisis, particularly since its development is uneven. In Germany and Spain, capex is positive, while it continues to shrink in Italy and France. Recapitalized banks, declining interest rates and ample liquidity coupled with a better outlook should lead to a return of investment.

In line with the constructive flow of economic indicators, the European Central Bank (ECB) has revised upwards its growth forecast for the first time since the financial crisis. Deflation, which was a huge concern two months ago, has completely disappeared from investor radar screens once it became clear that the ECB would launch a large asset purchase program (QE) and once it appeared that growth was picking up. It is worth keeping in mind however that in March, inflation data was negative (-0.1%) and that core-inflation, while positive, has continued to slow down to +0.6%. Any activity slowdown will revive the specter of deflation.

On the other side, in the US, economic data published since the start of the year provides a more complex and less appealing picture. Virtually all economic data speaks for a slowdown in the first quarter of 2015. The key question is whether this is temporary or not and what are the implications of the Fed’s first rate hike. Several factors explain the American economic slowdown. The first factor is very temporary. In January, snowstorms hit central and Eastern States and in February the temperature was very cold, hindering construction works. As it was the case in the first quarter of 2014 as well, harsh winter impacts negatively the US economy. The second two factors are cyclical and probably cancelled each other. On the one hand, the strength of the USD weighs on exports, but on the other hand, the low oil price increases considerably the purchasing power of American consumers. Besides these factors that currently weigh on growth, we are confident that underlying growth remains robust. Consumption, representing about 70 % of the GDP, is supported by a robust labor market and slightly rising wages. In our view, the current episode of weak growth is a soft patch that would fade away in the coming months.

Against this background, we expect the Federal Reserve to raise rates for the first time since the Global Financial Crisis sometimes in the second half of the year. While a June rate hike is not completely ruled out, it appears unlikely today. As the Fed repeats, it depends on data, as we are. This adds uncertainty regarding the exact timing of the so called lift off. In our view, it is more important to focus on how fast the Fed will increase its fund rate rather to focus only on when the first rate hike will take place. We think that it will do it very gradually.

Analysis by Ethenea. Yves Longchamp is Head of Macroeconomic Research at ETHENEA Independent Investors AG. Capital Strategies is Ethenea  distributor in Spain and Portugal.

UK Elections: The Dog That Didn’t Bark

  |   For  |  0 Comentarios

Elecciones en Reino Unido: “El perro que no ladró”
CC-BY-SA-2.0, FlickrPhoto: Caroline. UK Elections: The Dog That Didn't Bark

What a night for the Conservative party. They out-polled all the predictions and will be staying in Downing Street to govern on their own, thanks to the small majority they look likely to achieve. Comparisons with 1992 seem valid: David Cameron is the New John Major, the man who confounded the pollsters!

For the markets, the election was the dog that didn’t bark. Short-term uncertainty has been avoided and growth headwinds caused by electoral uncertainty have abated. Equities have rallied somewhat, and the pound has bounced. Looking further ahead, the markets seem unlikely to push these moves too much further. The likelihood of a fresh round of austerity probably means less growth and a different policy mix than seemed likely only yesterday. Slower growth may dampen equity market enthusiasm, while less upwards pressure on interest rates could keep a lid on sterling.

Renewed challenges

Politically, there remains the possibility of renewed challenges in the weeks and months ahead. The failure of the Conservatives to win more convincingly means the government will have its work cut out. After the 2010 election the coalition government held 364 seats. The Conservative government will be lucky if it has 329, when technically 326 seats is a majority (BBC data/projections). The weakness of Labour may help the Tories, but the guile of the Scottish Nationalist Party (SNP) will not. More importantly, problems arising within the Tory party may be a challenge to effective government.

John Major had a much more stable platform than Cameron after the 1992 poll, yet struggled to govern convincingly. “In government but not in power” was the view of Norman Lamont, one of Major’s own MPs. Major struggled to deal with the rebels and backstabbers in his own party, and the Conservatives may reprise that experience in the years ahead, especially when the current generation of euro-sceptics seek to achieve their primary aim of leaving the European Union (EU). The fact that David Cameron has already announced he will stand down during the life of the next parliament likely diminishes his authority and raises the probability of fractious behaviour from his own side.

The last Prime Minister?

The second challenge that faces the government and the country post-election is what to do about Scotland. The disaster suffered by Labour north of the border means that Labour – like the Conservatives – is no longer a national party. The nationalists are the big winners in terms of seats, but because of Labour’s failure to do better in England they have no platform to influence what happens in government. This is a receipt for anger and frustration in Scotland. Whether that visceral response is harassed by the nationalists or defused by the Conservatives could be immensely important for the stability of the government and the country. Looking at the form books, you would fancy the nationalists to make the most of the opportunity they have won for themselves. The Scottish schism is real. Could David Cameron be the last Prime Minister of the United Kingdom?

The third and possibly most important challenge for the new government is Europe. Business leaders have voiced their concerns about the dangers of ‘Brexit’, and under different circumstances you would expect the Conservatives – the party of business – to listen to their cries. But these are not ‘normal’ times, and Cameron is obliged to lead the country down the road to an In-Out referendum and, possibly, an exit from the EU. The clock won’t start ticking today, but it will at some point: if it looks like Cameron could fail to deliver a vote for staying ‘in’, the markets will take fright.

The smiles fade

Through the prism of party politics it was a good night for the Conservatives. But the challenges of delivering effective government, keeping Scotland in the Union, and dealing with a European issue that has split the Conservative party for the last 30 years may soon see the smiles fade. If that isn’t enough to worry about, demands for electoral reform will come thick and fast once the opposition parties have dusted themselves down. Today Cameron looks like John Major. He must be hoping people aren’t saying the same thing in five years’ time.

Together will Paul O’Connor, Bill heads up Henderson’s Multi-Asset team.

The UK Economy and Financial Markets after the Election

  |   For  |  0 Comentarios

¿Amenaza el resultado de las elecciones británicas el estatus de la City?
CC-BY-SA-2.0, Flickr. The UK Economy and Financial Markets after the Election

The British election has delivered a stunning set of results, mostly unpredicted by the pre-election polls. Whatever the explanation for these forecasting errors (e.g. “shy Tories” not disclosing their true feelings to pollsters), the recovering economy and the lack of trust in the Labour programme must have played a large role in returning David Cameron and his Conservative party to Downing Street. Gains of over two million jobs in the past five years combined with low inflation and the start of real wage gains for the first time since the recession of 2008-09 will all have played a role in shaping voters´preferences for a party that has put economic credibility and the restoration of sound public finances at the top of its priorities. In addition, economic surveys show that consumer confidence is at a three-year high while the consensus forecast of economists for UK real GDP growth is 2.6% in 2015, a rate far ahead of most of the Eurozone. All these factors will have contributed to Camerons unexpected victory.

The fact that the Tories have won an outright majority of seats in Parliament (330 out of a total 650 seats) automatically means that the near-term uncertainties that threatened to dominate financial markets in the immediate weeks ahead can be dismissed. Now there will be no slide in the currency during a fractious process of coalition-forming, and no jitters in the stock market about a possible rejection of the Queen´s speech (which outlines the government´s legislative programme) by the House of Commons. Already sterling (+1.6% against the US dollar at midday on Friday, May 8th) and the FTSE100 (+1.87% also at midday) have bounced back from recent losses, while sterling bonds have rallied.

Moreover, the continuity of the Tory-led Coalition´s economic programme fiscal discipline in the public sector with a preference for allowing the private sector to promote economic growth and prosperity rather than widespread intervention in the markets (such as Ed Miliband´s plans to impose a freeze on electricity and gas prices or to re-write hundreds of thousands of “zero hours” employment contracts) will be a relief to business and the financial markets. Although the Coalition government failed in its aim to reduce the structural budget deficit to zero within a single parliament -in part due to the ring- fencing of expenditures on health and overseas aid, as well as numerous tax reductions on personal incomes especially at the lower end of the income scale – there can be little doubt that the Tories will seek to resume this programme, restraining public expenditure on both current and capital account until tax revenues have been restored to stronger growth.

On the monetary policy front there is no reason to expect any change in the mandate given to the Bank of England to maintain a 2% inflation target. The Monetary Policy Committee of the Bank is due to meet and report next week (May 11) on a meeting held on May 7 and 8. With CPI inflation in March well below target at 0% year‐on‐year (headline) and 1.0% (core) it is likely that the MPC will vote to keep rates unchanged at 0.5% and to leave the amount of asset purchases outstanding also unchanged at £375 billion. As the UK economy continues to recover it is probable that investors will start to anticipate a gradual series of rate rises later in the year, starting, in my view, after the US Federal Reserve starts to hike US rates.

In contrast to the resolution of these short-term uncertainties, the Conservative victory in the election brings one major, longer term uncertainty, the prospects of Britain´s future in Europe. David Cameron has promised the British electorate the opportunity to vote in an “in‐out” referendum on Britain´s membership of the European Union by 2017, a commitment that he will find impossible to avoid. Opinions in the country are very divided.

One side views Europe -with its heavy- handed regulations on everything from labour markets to the names of cheeses, its slow-growing economy, and its demand for large annual payments from Britain to the common budget, and its over bearing judiciary which is constantly expanding the areas of its remit -as an economic sinkhole that the country urgently needs to escape from before it suffers a Japanese- style fate of one or more “lost decades” of growth.

The other side views Europe as integral to Britain’s place in the world and the key to its ability to play a meaningful role in any international strategic, diplomatic or economic dialogue with other major powers such as the US, China or Russia. This side also claims that, with the EU being Britain’s largest trading partner, as many as three million domestic jobs are essentially dependent on British membership of the EU, and if Britain left the EU it would soon suffer debilitating trade or financial discrimination that would damage inward investment into Britain and hurt the country’s long term growth prospects.

Of major importance to the UK when considering its EU membership is the City’s position as Europe’s financial centre. The financial services industry accounted for around 8% of UK GDP and 12% of tax receipts in 2012. In addition, London is home to the European headquarters of many of world´s largest financial institutions. Major uncertainty would arise in the event of a UK exit from the EU, specifically concerning whether the UK would be excluded from the common market in financial services and passporting rules. It is legislation from Brussels that enables the City to carry out these activities and guarantees unrestricted access under pan-European regulations across every member state. For all these reasons the longer term uncertainties will remain, at least until 2017.

While the Conservative party is traditionally divided in its views on Europe (and at times in the past 30 years the issue has threatened to tear the party apart), the newly resurgent Scottish Nationalists are ardent Europeans, while Labour is generally pro‐European. The business world is by no means united in favour of EU membership. These divisions and the Prime Minister´s agenda for an “in-out” referendum will pose a major challenge to the new government.

In summary, although the election has resolved some short-term unknowns, longer term unknowns still remain.

Opinion Column by John Greenwood, Chief Economist Invesco

An Early Upgrade in Bonds Will Prove Rewarding

  |   For  |  0 Comentarios

Es el momento de apostar por la deuda de mayor calidad
CC-BY-SA-2.0, FlickrPhoto: Soclega. An Early Upgrade in Bonds Will Prove Rewarding

Over the last few months we have been raising the quality of high yield bonds in the portfolio. At this stage in the credit cycle it seems sensible to avoid undue risk while at the same time acknowledging that unconventional monetary policy is elongating the cycle. While we do not see an imminent risk of defaults, we believe an early upgrade will prove rewarding and have been reducing our weight in CCC in favour of BB rated bonds.

What has prompted the rise in quality?

  • Energy sector: Deutsche Bank estimate that a third of US single B and CCC energy high yield bonds are at risk of restructuring or default if the current low oil price persists for a few quarters. While we see the energy sector as a special case, it is likely to have a knock-on effect on sentiment towards lower rated bonds as pressures among energy borrowers cause US default statistics to deteriorate.
  • Liquidity: Banks have stepped back somewhat from their traditional role as market makers. This role is a victim of well-intended regulation having the opposite desired effect as stricter requirements on bank capital and trader remuneration has led to a reduction in banks’ willingness to take risk onto their own books. We need to be mindful that liquid assets can become illiquid if everyone trades in the same direction. Premiums will be paid for better quality assets so it makes sense to own them early.
  • US monetary policy: The US Federal Reserve (Fed) is preparing the way for an interest rate rise. In March, the Fed scrapped its pledge to be “patient” before lifting rates, although this was tempered by rate projections being pushed out. The Fed has been good at providing guidance but we are wary of complacency. Rewind back to summer 2013 and investors may recall the taper tantrum when bonds sold off on suggestions the Fed would taper its asset purchasing program. Tightening still has the capacity to shock!

Recent weakness in some of the US economic data means expectations of a rate rise have drifted out somewhat, but we want to own the better quality bonds before investor concerns rise. A rise in interest rates in the US is likely to lead to tighter credit standards at banks and this may make it harder for some companies to refinance. There has been a close relationship historically between tightening credit standards and the default rate as shown in the chart below.
 

Ampliar

 

Regional differences

The shift in credit quality improvement within the portfolio is primarily among US bonds because the credit cycle in Europe is younger and the monetary policy background is different. They say “don’t fight the Fed” but we don’t want to fight the European Central Bank (ECB) either.

The ECB’s quantitative easing (asset purchases) is pushing down yields on sovereign bonds, such that €1.7 trillion of Eurozone bonds were negative yielding in mid-April. This figure is several times larger than the entire euro high yield market, as shown in the chart below. With ECB quantitative easing set to remain in place until September 2016 this creates strong technical support for European high yield bonds. This is because a cascade effect takes place with investors moving down the credit spectrum in search of a positive yield, supporting our overweight position to the region.
 

 

Ampliar

 

Identifying improvement
 
Credit ratings are not static and as active managers we have the opportunity to benefit from identifying bonds with improving credit quality. During 2014 the fund profited from ratings upgrades to bonds issued by GKN, the automotive and aerospace group, and Grand City, the real estate investment trust.
 
We hold perpetual preferred stock in Ally Financial, formerly GMAC, the auto financing group. We expect an eventual move to investment grade status due to improvement in the auto business, growth of the bank and successful refinancing of the capital structure resulting in a lower cost of funds and improved net interest margins. We also look at valuation opportunities where industry or stock-specific shocks have led to excessive pessimism but where credit fundamentals remain sound. This explains our holdings in bonds issued by Tesco, the supermarket group, which is reinvigorating its business after losing market share to discounters, and Chesapeake, the energy company, which was caught up in the negative sentiment towards energy companies, despite its strong balance sheet.
 
Taken together, the adjustments to the credit quality of the portfolio strike a balance between reducing risk while retaining exposure to the returns potential of high yield. The portfolio now has a weighted average yield and spread that is slightly lower than the benchmark.

 

Kevin Loome is Head of US Credit at Henderson Global Investors.

A Rate-Rise in the U.S. is Barely Priced In by the Markets for This Year

  |   For  |  0 Comentarios

Los mercados apenas han descontado una subida de los tipos estadounidenses para este año
Photo: Ian Sane. A Rate-Rise in the U.S. is Barely Priced In by the Markets for This Year

The broad-based stock market rally that characterised much of the first quarter of 2015 ran out of steam in March. During the month, investors focused on weaker US economic data, renewed geopolitical tensions in the Middle East and a corresponding bounce in the oil price. In bond markets, benchmark 10-year government yields remained extremely low, with German Bund yields finishing the month at just 0.18%. In the US and UK, 10-year yields also moved lower, reflecting the softer tone of US data and the ‘gravitational pull’ of the ECB’s QE programme. In credit markets, there were some signs of indigestion following heavy new issuance, but these concerns have eased somewhat following the seasonal lull in activity over Easter.

Looking to the second quarter, there are three important issues which investors will have to consider – the trajectories of interest rates, currencies and economic growth. On the interest rate front, much was made of the Fed’s decision to drop the word ‘patient’ from its March policy statement but the bottom line is that, seven years on from the financial crisis, we are still living in extraordinary times. Consumers and governments in the developed world remain overlevered and overindebted and companies across a number of sectors are struggling to maintain pricing power. In my opinion, it is not obvious that there is a need for any aggressive rise in interest rates, particularly given the deflationary impact of lower energy prices. At the time of writing, barely one US rate rise is priced in by markets for this year, and in the UK markets have pushed the timing of the first rise all the way out to August 2016. The eurozone and Japan, meanwhile, are expected to keep policy extremely accommodative.

Interest rates provide a neat segue to currencies. The combination of European and Japanese QE and the expectation that the US should raise rates this year has driven a very strong rally in the dollar index over the past six months. We do not expect the dollar to maintain its very robust rate of appreciation but the greenback remains the global reserve currency by default. Moreover, further short-term volatility in the euro/dollar exchange rate cannot be ruled out as Greece appears to be heading towards a ‘day of reckoning’. In the long run, a Greek exit from the euro could be a positive for the country but the period of adjustment in the short term would be extremely painful. But, by itself, a ‘Grexit’ would not be a disaster; the real issue is what happens elsewhere in the eurozone, particularly if Greece does succeed, over time, in going it alone.

The global economic growth outlook appears to be deteriorating at the margin. The recent weaker US data is almost certainly linked to weather-related disruptions and other one-offs such as the West Coast ports strike, but it was probably unreasonable to expect the US to keep outpacing the rest of the developed world by such a wide margin. At the corporate level, US companies are undoubtedly feeling the pinch of the reduction of capex in the energy sector and the stronger dollar. Our own view is that the US economy is in a soft patch, and this is likely to be reflected in Q1 US GDP and probably Q1 reported earnings. Nonetheless, for risk assets, and indeed the global economy in general, it is important that the recent ‘blip’ in US data is nothing more than that.