I’ve just returned from Colorado Springs, where I attended the annual Barclays High Yield Bond and Syndicated Loan Conference. The question that has dominated global credit markets in the past 18 months inevitably took centre stage: where to for the price of a barrel of oil?
However, besides the energy sector, investors were also interested in how the countervailing forces of the European Central Bank’s corporate bond buying programme, the CSPP, and the potential for Brexit were impacting global credit markets.
Evergreen topics like managing credit in an illiquid market and determining where we are in the cycle also featured. As a London-based global credit investor attending a conference in the US, it was no surprise that the first thing people wanted to discuss was the UK potentially leaving the EU. Besides expressions of incredulity about the logic of doing so, US investors cited the 23 June referendum as a reason for containing their sterling or euro risks, or both.
Brexit discussions were often followed by anything related to the CSPP because it is clearly having a real impact on global credit markets. This exogenous force has driven European spreads past fair value, making the region less attractive as a global relative value play than, say, the US and emerging markets.
As a result, flows into Europe from the US have slowed and, as we have previously discussed, flows from European to US credit markets have increased, just as they did from Japan after the nation’s central bank implemented its negative-rate policy.
Since 2011, the poor trading liquidity in global credit markets has been a constant theme. Beyond these general observations, our discussions with peers and presentations by Barclays have confirmed our long-held belief that, on a more granular level, the credit market’s liquidity has bifurcated. Large issues from public companies, including credit-default swaps – which allow banks and investors to better manage risk – still trade relatively well and in most cases on a ‘principal’ basis, whereas small issues trade very thinly (if at all) and almost exclusively on an ‘agency’ or bespoke basis. And while there has always been a gap between liquid and less-liquid instruments, it’s now like there is an ocean between the two.
This distaste for smaller companies’ debt securities has led to a slowdown in smaller, illiquid primary-market issuance. Because the market signals are not entirely clear, another hot topic at the conference was pinpointing where we are in the credit cycle. To that end, some cited rising financial leverage, tightening credit standards and an increase in defaults as signs that the credit cycle was turning more malevolent.
While it is not hard to argue that this is the case, others – including Barclays credit strategists – point to the spike in default rates as being in near-isolation among commodity-related companies, and note the stability of economic leading indicators and the US employment rate as showing signs that the cycle has still got some life to it.
As for Hermes Credit, our conclusion from the conference was to continue ignoring the siren song to invest in securities from ‘one-bond-only’ companies just because they look cheap. In addition, there seems to be a widespread aversion to European credit in the US due to valuations and event risk at the moment, which speaks to our preference for US credit. That said, the negative sentiment brought by the Brexit referendum has created relative-value opportunities in UK credit and some corporate capital securities in euros.
Taking a broader view of the market, debate about the status of the credit cycle reinforces the importance of issuer and security selection in the current environment.
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