September closed off a weak quarter for risk assets as sentiment was shaken by the correction in emerging markets and the downgrades in global growth outlook.
As we had expected, the Federal Reserve resisted calls for an interest rate hike and was quite open in acknowledging that it might be too early to appropriately judge the severity and the implications of the developments abroad.
However, this accommodative and cautious tone contributed to a gradual dissipation of investors’ complacency and took a toll on equity and credit markets.
Accordingly, the high yield market posted negative returns for yet another month (in the -2.5 per cent region for both EUR and USD high yield) and the year to date returns slipped into negative territory (-0.5 per cent and -2.5 per cent for the EUR and USD Bank of America Merrill Lynch Indices respectively).
However, as the month came to an end, there were early indications that the sharp increase in yields had made valuations attractive enough to prompt an opportunistic increase in positions.
Indeed, the last trading session of the month was positive for the major equity and credit indices, notwithstanding the fact that the day was marked by below expectations data (the preliminary September inflation reading for Euroarea unexpectedly dipped below zero and the unemployment rate increased).
While volatility is likely to prevail for some more time, with high yield spreads reaching multi-month highs and the prospect of additional monetary stimulus in Europe, expectations for a market bottoming are due to increase as higher liquidity and more attractive entry-points bode well for risk sentiment.
In the Investment Grade space, the forecasts for a rebound in supply did not come to fruition as the demand for the asset class was impacted by the general market backdrop but also by issuer-specific risks such as the Volkswagen scandal and, earlier in the month, by negative headlines on German utilities companies.
Against this backdrop, the EUR corporate hybrids weakened significantly while the investment grade spreads widened; however for the latter, yields found some support in the drop in government (i.e. benchmark) rates and the monthly total return, while negative at -0.7 per cent, compares well to those of other asset classes.
Looking forward, I see scope for lower credit spreads although I expect volatility and uncertainty to remain with us and investors to increasingly discriminate between issuers based on their fundamentals.
My outlook rests on the more attractive valuations and on my ongoing belief that the ECB will (sooner rather than later) be forced to downgrade its forecast and announce new stimulus measures, which will eventually mean more money to be put to work. While risky assets should benefit from such a scenario, I would also expect the EUR higher rated bonds to benefit as they should reverse part of their spread widening.
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.