US Credit Market still a top performer

Year to date, High yield outperformed largely Investment Grade markets. Within IG credit market, corporates posted higher return than financials.

In terms of subordination, hybrid corporates outperformed subordinated financials.

US Credit Market still a top performer

We are well in the later stage of the credit cycle with more than 63% issuers increasing their leverage. Retail, Media, Healthcare & Technology sectors have deteriorated the most their debt ratios.

However, re-leveraging has begun 24 months ago ! Deleveraging plan and cost synergies could produce positive effects on the income statement in a growing US economy.

With the slowdown of the merger & acquisitions process and more favorable funding conditions in euro, supply expectations in dollar have been revised slightly down to last year’s $ 1.3 trillion gross supply.

But it’s largely priced! Over the last 5 months, $ Investment Grade generated 5.2% total return and 1.6% excess return over the treasury with a spread tightening of 20 bp.

With gradual oil re-pricing and the attractive carry offered by the asset class, $ High Yield are registering strong inflows. Default rate projected is around 5% while the market implies a rate of 8.5%.

Some diversification can be operated towards this juicy credit class.

Opportunities on EUR IG & HY markets

In anticipation of the ECB purchases’ beginning, credit risk premium rallied during 8 consecutive weeks to reach 120 bp over the government curve beginning of May. Eligible bonds spread tightened by 33% while non eligible bonds rallied by 16%. Corporate sector purchase program pushed corporate yields to a record low of 0.95%, the lowest level seen early last year. 65% of iboxx euro corporates post a yield below 1% compared to 38% end December; 9% are even negative or equal to zero!

The improvement in funding conditions has prompted many issuers to tap the market. The last 12 weeks, supply activity has been the third highest since the inception of the euro in 1999. Year to date, primary market is very buoyant with € 288 Billion issued where US issuers represent 25%. Debt buyback and maturity extension towards 10 years + are the main purposes.

Fundamentally, incentives are strong to re-leverage but willingness is still modest except for large companies. Low yield environment, high investors’ appetite, support from ECB program purchase and low risk premium are optimal conditions to encourage merger & acquisitions. Companies are seeking external growth in order to boost their earnings generation like Air liquide, Ab Inbev, Bayer…

Taking into account rising political risk in Europe, large supply and re-leveraging of some low beta names to offset profits deterioration, Investment Grade credit offers few opportunities in terms of spread compression. However, ECB CSPP will certainly cap any spread widening! We took profits on some positions and adopted a more defensive approach to have an investment grade credit exposure of 60 bp ( including financials & non financials)

ECB purchases will likely emphasize the supply scarcity and the illiquidity of the asset class; pushing investors to rotate to yieldier asset classes like high yield. Euro High Yield benefits from lower duration, higher risk premium, a still low European default rate (major bankruptcies are confined to US metals & mining and oil & gas industries), eased credit market conditions and strong technical factors as demand outpaced supply.