European Investment Grade Credit Market Outlook Q Introduction

Transcription

1 MARKET REVIEW European Investment Grade Credit Market Outlook Q Garrett Walsh, Head of Credit Research, Europe September 2014 Introduction European Investment Grade Credit continued to perform well over the past few months, despite an increase in geopolitical risks and a reappraisal of risk in the high yield markets. Through August in particular, when volatility increased in a number of markets, European credit spreads remained very resilient to negative headlines. Credit Spreads Narrowing Garrett Walsh Head of Credit Research-Europe Source: Bloomberg as at 19 September 2014 This is the latest example of what has been a secular trend since The European Investment Grade Credit market performed very strongly post-crisis and re-rated again following the famous whatever it takes statement from the European Central Bank (ECB) President Draghi in August 2012, which we show in the shaded area of the chart on the following page.

2 European Investment Grade Credit Performed Strongly Post-2008 European Investment Grade Credit performance in context Total Returns Quite High, Excess Returns More Muted We believe this chart offers a good representation of what happened in European Credit in Total returns have been quite high, while excess returns have been more muted meaning that much of the performance of the asset class has comes from the strong compression of government bond yields, which in turn have been driven by expectations of interest rate cuts and, more recently, the ECB performing some Quantitative Easing ( QE ) on Government Bonds across Europe. However, there has also been modest spread tightening and we think that the asset class remains well supported on a number of fronts.

3 First, a very strong technical picture there has been steady demand for investment grade corporate bonds through Given that investment grade credit has offered investors slightly higher yields than already compressed risk-free rates and low volatility (versus equities) - demand has remained strong through 2014 and we expect it to remain so over the coming months. Steady Demand for Investment Grade Corporate Bonds Throughout 2014 This is complemented by a scarcity of paper, particularly from the Banking sector. The European investment grade credit market has more bonds maturing than it has new issues we have net negative supply. This is mainly a reflection of deleveraging activity in the banking system (which remains pronounced ahead of the Asset Quality Review ( AQR ) - due end of October and corporates striving to keep their balance sheets under control to date. European Investment Grade 12 Month Rolling Net Issuance In our view, the technical picture has been a very important driver of credit spreads for Investment Grade Credit in Europe over the past few years.

4 Secondly- We believe that Issuer Fundamentals appear solid and are not deteriorating Looking at balance sheets and cash flows (for corporates) and capital levels (for financials), we believe that the fundamentals in the European Investment Grade Market are quite re-assuring as regards justifying current spread levels. European Corporate Leveraging (Net/Gross) Net leverage has been at a very reasonable level (by historic standards) and well below the peaks of the financial crisis. And the behaviour of corporates has been very good company management teams have been keeping their leverage under control reflecting a lack of strong growth opportunities and post-crisis conservatism as regards their financial ratios and rating profile. Given that the outlook for the European economy remains quite anaemic, we expect corporate behaviour to remain quite conservative (i.e. no aggressive re-leveraging) for as long as Europe remain in a Repair phase of the economic cycle. Banks are also acting in a very credit friendly manner: de-risking and re-building capital ahead of the comprehensive assessment (i.e. AQR and stress tests to be concluded in late October 2014). Re-financing risks are very low for the sector given that we have a new targeted long term refinancing operations facilities available from the ECB plus an asset backed and covered bond purchase programme. We expect the results of the comprehensive assessment to provide few negative surprises we do expect some banks to fail but we believe that most of the sector has undertaken preemptive capital raising which will remedy any shortfalls that may be identified.

5 Post-stress Test T1 Capital Levels all European Banks Above the 5.5% Minimum Threshold In our view, the fundamental picture in Europe is somewhat more supportive than in in the US, where corporate behaviour is slowly starting to become more shareholder friendly as the US economy moves into a Growth phase. Companies in the US are becoming more active in Mergers and Acquisitions and share buy-back activity is increasing both these areas are being funded more via debt issuance. Three- Valuations are increasingly full but not that expensive in historical context Credit is no longer cheap especially if one looks at yield levels - but there may yet be some scope for modest compression of credit spreads, given that the Technicals for investment grade credit remain so strong and as fundamentals are not deteriorating and we believe are unlikely to do so. Yields for European Investment Grade Credit at Historical Lows

6 Even if yield levels are very low, credit spreads are just slightly below average historic levels. Spreads are Still Above Historical Lows, and Just Slightly Below Average Therefore, it is interest rates that are very low, not credit spreads. Another way of thinking about valuations in credit is to look at spreads per unit of leverage, which shows how much investors are remunerated for every turn of leverage an issuer has. As you can see, the market is actually not paying much more than the historical average. Therefore, credit may not be cheap but spreads are not at alarmingly tight levels either. The Market is Paying Not More and Not Less than the Historical Average at Present

7 What we expect from the Credit Market over the next months We believe that investment grade credit remains one of the better areas for investors within the Fixed Income world. We expect net negative issuance in Euro Investment Grade credit of between 80 and 90 billion Euro. This, coupled with expected strong inflows into the asset class, should continue to represent a very favourable technical picture and be supportive for Investment Grade credit spreads in our view. The fundamentals remain good corporates in Europe are not re-leveraging their balance sheets given the uncertain economic outlook and this is unlikely to change anytime soon. Regulatory pressures are forcing banks to reduce risks and increase capital. Yield levels are low but credit spreads do not look that unreasonable versus historic levels especially in light of the supportive technical and solid fundamentals. It is not our base case but there is also a possibility of Quantitative Easing further down the line in the event that the European Central Bank s current policy measures are not enough to avoid deflation. Important Information Ratings given are as rated by Moody's Investor Service, the Standard & Poor's or Fitch's as applicable. Unless otherwise stated, all information contained in this document is from Pioneer Investments and is as of 26 September Unless otherwise stated, all views expressed are those of Pioneer Investments. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any services. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. Date of First Use: 3 October 14