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November, a mixed month for global credit

  • Investment Manager
  • Blog post submitted on 5th December 2017

In our commentaries for the month of October, we highlighted the fact that the strength of the credit markets had left most participants baffled and that, it was a matter of time when it would lose steam, and we opined that profit taking to begin to take centre stage in November together with some spread widening. This is in fact what happened in the first part of the month as markets in general sold off across the board. Sovereigns bonds led the retreat following ECB comments of complacency and all other fixed income asset classes followed suit. Equities came under pressure too, and there has been a great focus on the US tax reform.

At this juncture, the largest issue for the bond investor in credit markets, both the Investment Grade and High Yield investor, in EUR and USD, is the risk-reward profile being highly skewed away from the reward element. Record lows, in yields and spreads in almost ten years, notwithstanding the correction registered during the month of November, are the greatest indicators that markets had become toppish and ahead of themselves. In this vein, we think that the correction and profit taking was justified and warranted. However, on the flipside, fundamentals remain intact. Balance sheets are healthier than they were 12 months.

Credit rating upgrades are becoming the norm once again and no longer an exception. But nevertheless, the upside for credit remains very limited, while the downside is substantial. Having said that, we do not see any imminent major risks to derail the markets in the near term, so we hope so see out the remainder of the year relatively unscathed. But there are always issues lingering that can deteriorate and become problematic.

For example, Chinese real estate issue, higher tax rates in the US as well as problems within the Tech sector, all factors which have been fluid in recent weeks, could dictate market sentiment and push spreads wider, if they deteriorate. Per se, when viewed in isolation, they might not directly impact credit markets, but a sell-off in the US could well spill over across the Atlantic and have reverberating effects on Emerging Markets too.

After 21 months of bonds rallying (since February 2016) the hunt for yield has not yet fizzled out and, at current valuations, HY and EM in particular remain the more attractive sub-segment within the fixed income space. We do not expect any major hiccups and/or hurdles in credit heading into year end.

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