So far, this month hasn’t been particularly supportive for credit markets as a slump in commodities, an apparent change in investors’ growth outlook and persistent worries around China and emerging markets more generally took their toll on risk sentiment. On top of this, the lower liquidity that comes with the summer holidays likely added to the downside price reaction.
Looking at the Bank of America Merrill Lynch (BAML) Indices, so far this month the EUR and USD investment grade bonds posted positive returns of 0.3 per cent and 0.4 per cent respectively, as they benefited from the drop in government yields (aka benchmark yields).
The latter in turn reflects the higher likelihood of a delayed rebound in inflation after a renewed bout of weakness in oil and other commodities and perhaps greater acceptance of the idea that global growth recovery will continue to be a slow and prolonged process.
While it is hard to precisely measure the contribution of each of this factors, my assumptions seem to be supported by the recent fall in admittedly one of my preferred measures of long term inflation expectations, the 5 year-5 year inflation swap. The later reflects the 5 year inflation rate forecast by investors for 2020. For Eurozone, this rate stands at about 1.65 per cent as I am writing, after having rebound to 1.9 per cent earlier this year (still short of the two per cent threshold envisaged by many as appropriate for a healthy economy).
The lower risk appetite prevalent over most of this month’s trading sessions has also translated into negative returns for the high yield (HY) bond market (0.3 and 1.6 per cent for the EUR and the USD BAML High Yield Indices respectively). The large divergence between the performances of the two markets reflects to a large degree the different sectorial exposures.
More specifically, almost half of the negative return of the US HY reflects the plunge in energy which accounts for 13 per cent of the Index and lost 4.8 per cent month-to-date. By contrast, the EUR HY Index has a five per cent exposure to energy names and these have only lost 0.78 per cent MTD due to the virtual nil presence of shale-gas/oil issuers which are perceived as more vulnerable and the heavy weighting of state-owned names (Gazprom and Petrobras)
Other sectors that contributed to the lower return of the USD HY relative to EUR HY this month have been the basic materials and capital goods which each lost around 1.3 per cent as they are perceived as more sensitive to the global growth cycle and currency wars.
Again, the name composition helps to explain why these sectors were not such a drag for the EUR Index; most of the emerging market/ mining names rely on USD debt rather than on EUR bonds as commodities are generally quoted in USD terms.
Together, capital goods, basic materials and energy dragged the USD HY index down by 0.9 per cent month-to-date, while on the EUR HY index the impact was only 0.1 per cent. At the other end, the sectors more leveraged to the US economy have been quite resilient, with cable/satellite TV and healthcare posting positive returns and retail for instance losing a more manageable 0.3 per cent.
To conclude, in the current environment I remain of the opinion that EUR investment grade could benefit from the stabilisation of the government yields at lower levels and, within high yield returns could be enhanced via stock picking and correct sectorial positioning, in my opinion by avoiding commodities and focusing on names exposed to the US domestic economy.
Disclaimer: This article was issued by Raluca Filip, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.