Credit Market Daily #41 %author %

26-Oct-2022

Good Morning!

The Bear Market Rally continued yesterday – a strong day across equities, credit and rates.

Earnings wise – a smorgasbord of names report today – Kraft Heinz, Ford, Barclays, Heathrow, KPN, Ineos, Boeing, Elis, Aker BP, Dometic, and Accor to name a few.

Google and Microsoft both saw their shares down on the back of a miss in ad revenues and a warning of a slowdown in cloud computing respectively. We have Meta reporting today.

Away from that Sunak is in situ, with a cabinet with the fiscal statement expected to be delivered on Monday. The Times reports that he may delay this, which if true, will likely pressure Gilts.

Tomorrow we have the ECB -whether it causes a pause in the rally is anyone’s guess. (I think it should).

Today is a chart-heavy newsletter and we will kick things off with one of our favourites – the US MOVE Fixed income volatility index against the VIX Stock volatility index.

Over the week the MOVE Index has declined c.6% lower and the VIX c.4% lower, which given the move in rates makes sense.

However, this is your friendly reminder the MOVE touched pandemic highs earlier in the month, whilst stock volatility did not manage to peak above 34.

With rates at the forefront of Central Bank Rate hikes, Quantitative tightening, curves calling recessions and LDI margin call debacles they serve as an early warning system relative to equities.

I can only think that stock Vol is low because the amount of liquidity in the system is still large enough to support equity valuations. I am really interested to hear people’s thoughts on this – comment below!

Credit

High Yield

Xover moved -20bps tighter on the day to 565bps, down from its recent peak of 648bps earlier in the month with pandemic wides being 708bps.

Xover has consistently underperformed relative to the Investment Grade main index.

Looking at the ratio of Xover: Main ratio, the relative value remains Xover Cheap/ Main Expensive and the ratio has been normalising with the large moves tighter.

Interestingly, the levels in the ratio have not hit anywhere near pandemic wides, and this has a lot to do with the fundamental outlook for IG names becoming more of a factor in spreads as we head into a much lower (negative) growth environment.

The knee-jerk sudden stop nature of the pandemic very quickly put high-yield business models in question and Xover’s use as a liquid hedge, both mean that I don’t think we see the Xover: Main ratio reach pandemic levels any time soon, if at all.

Certainly, I think it remains above its 10-year average of 4.6x for most of the next 3-6 months.

Similarly, the basis or spread between the synthetic Xover Index and its cash equivalent has been normalising, having peaked on the 27th of September at around +95bps, is now sitting at -47bps, considerably closer to its 10-year average.

Given the level of cash on balance sheets – our investor survey with Bloomberg Intelligence reported High Yield investors hoarding an average of 7% cash on their balance sheet – the highest since the survey began, and the lack of new issuance there are some very strong technicals at work helping to keep a lid on cash spreads.

The basis at the pandemic was its most negative, with cash underperforming significantly – essentially un-hedgeable. Now the tables are turned and cash spreads are being driven much more by fundamentals than systemic risk.

I think that the relationship between cash and Xover should continue to normalise over time as portfolio cash balances come down.

For that to happen though cash spreads likely need to widen with most survey respondents saying European High Yield was cheap but had gotten more expensive relative to Q3.

Turning to performance – High yield enjoyed a positive day yesterday. However, it again underperformed Investment Grade and Equities given the rally in rates.

European, Sterling and Dollar High Yield indices’ spreads moved -2bps (Z+613bps), -2bps (Z+775bps), and +2bps (Z+514bps) respectively.

In terms of total returns on the day, Euro HY returned +46bps, GBP HY+36bps and USD High Yield +54bps.

Of note, Italian gaming company CIRSA is back in the market with its €350m 5-year, non-call 2-year deal. which is positive for primary and will serve as a litmus test for further issuance.

Leaders and Laggers

Investment Grade

So, we know that the Investment Grade Main index has outperformed its High Yield sibling Xover. How does it compare to Financials?

Banks are firmly in the driving seat within Investment Grade, which given the rise in rates and expected rise in net interest margin makes sense.

Add to that good capitalisation and bad loan reserves have yet to grow and you could argue that this will be the status quo for some time to come.

This earnings season was described as likely to be “an embarrassment of riches” for the banking sector.

What could impact the relationship between the Main and Senior Financials index could be if governments sit up and decide that a windfall tax on that embarrassment helps them balance the books – watch out for Monday’s Budget.

Investors have consistently been overweight banks in our HY investor survey as well.

Looking at the ratio of the Senior Financials index to the Subordinated Financials Index hints investors have been willing to take more risk within the sector.

The ratio of the Sub Financial index to the Senior Fin indices is trading below its 10-year average of 1.98x at 1.75x. during the Pandemic, it reached 2.22x and has moved lower since as subordinated bank risk is priced higher.

Turning to Performance.

In Spread terms the IG EUR, GBP and USD indices moved -0.5bps (Z+227bps), -5bps (Z+233) and -0.5bps (Z+160).

Sterling Investment Grade’s outperformance is likely the catch-up in spreads relative to rates we were expecting.

Total returns for the indices were strong – EUR returned +73bps, Sterling +84bps and Dollar +110bps.

Rates

Rates in the UK and US had another strong day.

Gilts had a volatile day with yields tighter on the open, widening and then back tighter again with the belly of the curve outperforming.

Tomorrow we have the ECB and we will be keeping an eye on the Italy BTP- German Bund spread which has tightened to 219bps from recent wides of 250bps.

A 75bp hike is expected.

The 10-year Treasury, Gilt and Bund yield 405bps, 360bps and 217bps respectively.

Equities

Following another strong day yesterday European and UK indices are opening flat to small down as earnings come to the fore along with the prospect of more central bank action tomorrow.

Today’s Events

Eco Data

Eurozone M3 money Supply, New Home Sales and Mortgage Applications in the US

Today’s Reporting

Accor

Aker BP

Amplifon

Balta

Boeing

Ceconomy

Constellium

Dometic

Elis

Ford

Garrett Motion

Heathrow

Hilton

Kraft Heinz

Nexans

Norwegian Air

Penske Automotive

PGS

Saipem

Technip

What Has Caught Our Eye

FT: “Weak pound adds £6bn to UK company dividends”

Dollar strength is not all bad…

Around two-fifths of UK-listed businesses declare their dividends in dollars or euros. Those income streams are now worth much more than they were last year, as the value of sterling has slipped to multi-decade lows.
Joshua Oliver, FT, 25-Oct-2022

Man Group: ” ‘once in a cycle’ opportunity in UK Credit”

Whilst there is something to be said for not asking a barber if you need a haircut, this article from MAN group looks at the relative value between the equity and debt of UK-listed companies and comes to the conclusion the latter offers significant value.

Divergences between equities and bonds of this magnitude are highly unusual. We attribute it to the greater efficiency of the stock market, while the credit space has been slower to react and perhaps weighed down by technical liquidity concerns. The moves nevertheless offer bondholders the widest margin of safety they have seen in this area since the financial crisis, with the exception of a few days at the height of the Covid panic in March 2020. We view this as a once-in-a-cycle opportunity, especially for those who believe inflation is decelerating and wish to lock in nominal yields of around 9% for the long term
Mn Group, 25th-Oct-2022

Credit Market Daily #41