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The recent market rally and European HY valuations


This week’s market rally emerged as a key indicator of the sensitivity markets hold vis-à-vis the trade war saga and monetary decisions. Just as a reminder, in the last week of the year, markets crashed on the US Federal Reserve’s monetary decision of hiking for another time in 2018. Indeed, the Federal Reserve (Fed), as it should be, ignored the pressures imposed by Trump not to hike interest rates given the turbulent markets. Let’s not forget that the Fed is an independent body and its prime mandate is price stability and employment. In this regard, in my opinion its decision was based on the lagging indicators, such as inflation data and low unemployment, which were within their range. To a certain extent, looking at the probability for that hike, markets were pricing-in such decision. So why did markets crash?

In my view, markets were more conditioned by not getting some sort of comfort in the Fed’s statement following the hike decision. Indeed, the Fed ignored the empathy preposition, which markets were looking for following a very harsh year, a year in which markets tumbled to levels last seen in 2008.

On the contrary, last Friday despite the very strong jobs report, Powell, the Fed’s chairman added the word ‘patient’ in his statement, a move which market participants digested very positively. Furthermore, this week’s trade war meeting was another comforting outcome for investors who are expecting a positive outcome, following the very unexpected statement from Apple, which emerged as another shocking news for market participants which increased pressures on politicians to strike a deal.

Looking at today’s valuation within the credit space, we are at levels close to those witnessed in March 2016. In fact, European High Yield is now offering a spread of circa 520p, following the remarkable widening in the second half of 2018. Indeed, looking at these spreads one might be tempted to dip-in selectively at these attractive levels. However, the fear of the unknown is undoubtedly still haunting investors following a very distressful 2018.

In my view, despite the fact that we might experience further volatility in the interim, we should see HY spreads stabilise at the 550p levels based on a number of supporting factors. In my opinion, we might see a macro slowdown, but I do not concur with the view that we’re heading into a recession. A slowdown in the economy doesn’t automatically imply we’re moving into a recession. My rationale is based on my sole view that the Fed and the ECB should ease their stances (being more emphatic vocally), while China as promised should continue to stimulate the economy. Indeed last week it cut its reserve ratio requirement for banks. Thus, all in all we should see some support, unless being faced with a very negative outcome from the US-China trade war front.

This week, for the first time since October 2018, we were convinced buyers of European HY names as we opted in dipping into selective names, which were more hit as a sector rather than on specifics. At these spreads we opted to take the plunge as historical averages are showing a buying opportunity. So yes, it might be appropriate to dip-in for those smart investors who sat on cash for the past months.

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