Outlook AWS
For professional investors and advisers only
November 2013
Schroders
Outlook 2014: European Corporate Bonds Alix Stewart, Fund Manager – Fixed Income Not many people are putting any bond asset class at the top of their performance charts for 2014. That will probably prove to be correct, but one of the first rules of investing is not to put all your eggs in one basket, and there remains plenty of structural demand for fixed income as an asset class. So what are the opportunities for the year ahead in bonds? Our roadmap has been telling us for some time that if the US and European economies are on the same path, the Europeans are at least 18 months behind the US. It is questionable whether it is even the same path, given the differing monetary policy responses by the respective central banks. This leaves the European credit market at somewhat of a cross roads. –– The European market is at a totally different part of the credit cycle to the US, and indeed most of the rest of the world –– The ECB was spooked by the recent falling inflation data across Europe and it is likely to have to do more monetary easing to reach its goal of price stability –– We are constructive on European credit markets, and by extension parts of the sterling market which still look good value comparatively, as rates risks can be hedged out.
Europe and the credit cycle If you look at fundamentals, the European market is at a totally different part of the credit cycle to the US, and indeed most of the rest of the world. Our credit cycle clock currently shows the eurozone economies in the stabilisation phase – which is a supportive and benign environment for credit.
BUBBLE
(Slowing growth, rising deafults, wide credit spreads)
RELEVERAGING
STABILISATION
(+ve growth, M&A up, low defaults, lending picking up)
“Our credit cycle clock currently shows the eurozone economies in the stabilisation phase – which is a supportive and benign environment for credit.”
CRUNCH
(Growth momentum fading, strong credit growth for an extended time)
(Low growth, deleveraging, defaults off the peak)
Source: Schroders. The distance from the centre indicates the strength of Schroders’ credit team’s conviction.
In contrast, the US and the UK economies are looking quite firmly in the releveraging phase, which is definitely not so bond-holder friendly. Shareholders in this phase demand far greater use of cash – and indeed management can find far more uses for it – instead of sitting on balance sheets. Mergers & acquisitions and releveraging behaviour such as leveraged buy-outs are a common feature of this part of the cycle. The worst parts of the cycle for corporate bond-holders, however, come in the bubble and crunch phases – which is where we see much of the emerging world currently.
Outlook 2014: European Corporate Bonds
EM crunch Quite how soon the crunch will really come to emerging markets is probably down to external dollar liquidity, and it may not be a 2014 occurrence. It is a real risk though, given the speed of credit growth and how these countries have benefited by having their yields suppressed in the world of quantitative easing (QE), in which money is plentiful and volatility is suppressed. If you combine this with receding fears of a eurozone break-up and underinvestment in European assets, then the outlook looks quite supportive for European markets – especially credit markets. The problem is that all bond markets and credit markets are historically highly correlated. Valuations look fair at best (and short term we see some worrying signals) and in any more taper-induced rates sell-offs it is hard to see European markets avoiding the fall-out completely (just look at what happened in May/June).
Alix Stewart Fund Manager – Fixed Income Alix Stewart started her investment career in 1994 and joined Schroders in 2012 as a Credit Portfolio Manager. Prior to joining Schroders, Alix worked for UBS Global Asset Management where she was Head of UK Fixed Interest. Earlier in her career she also worked as a corporate bond fund manager at SWIP, Gartmore and Standard Life Investments.
Further ECB easing What is clear, however, is that the European Central Bank was spooked by the recent falling inflation data across Europe and it is likely to have to do more monetary easing to reach its goal of price stability. This is at odds with the UK and US, where QE is becoming passé and central bankers are looking for a way out of it as soon as they can – without upsetting the front end of rates markets too much and choking off the recovery before it fully gains hold. While markets, therefore, can speculate on whether forward guidance calling for no rate rises before 2016 or so in both the UK and US will materialise, there is no such speculation likely in the eurozone. Credit to outperform cash That means that un-sexy returns of 2% or so this year – which should be possible in the European investment grade market for 2014 (and potentially more if you have a strong alphagenerating fund manager like Schroders) – still look decent versus virtually nothing on cash. All that leads us to be constructive on European credit markets, and by extension parts of the sterling market which still look good value comparatively, as rates risks can be hedged out. Volatility is very low currently so there will be spikes which widen spreads and provide decent entry points over the year. Should liquidity withdrawal elsewhere in the world cause more issues for emerging market economies and dollar credit, we see the European credit market as a safer haven to have your fixed income investments in. Who would have said that 18 months ago?
“In contrast, the US and the UK economies are looking quite firmly in the releveraging phase, which is definitely not so bond-holder friendly.”
Important information: The views and opinions contained herein are those of Alix Stewart, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Issued in November 2013 by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA, which is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped or monitored. w44680
November 2013
Schroders
Outlook 2014: European Corporate Bonds Alix Stewart, Fund Manager – Fixed Income Not many people are putting any bond asset class at the top of their performance charts for 2014. That will probably prove to be correct, but one of the first rules of investing is not to put all your eggs in one basket, and there remains plenty of structural demand for fixed income as an asset class. So what are the opportunities for the year ahead in bonds? Our roadmap has been telling us for some time that if the US and European economies are on the same path, the Europeans are at least 18 months behind the US. It is questionable whether it is even the same path, given the differing monetary policy responses by the respective central banks. This leaves the European credit market at somewhat of a cross roads. –– The European market is at a totally different part of the credit cycle to the US, and indeed most of the rest of the world –– The ECB was spooked by the recent falling inflation data across Europe and it is likely to have to do more monetary easing to reach its goal of price stability –– We are constructive on European credit markets, and by extension parts of the sterling market which still look good value comparatively, as rates risks can be hedged out.
Europe and the credit cycle If you look at fundamentals, the European market is at a totally different part of the credit cycle to the US, and indeed most of the rest of the world. Our credit cycle clock currently shows the eurozone economies in the stabilisation phase – which is a supportive and benign environment for credit.
BUBBLE
(Slowing growth, rising deafults, wide credit spreads)
RELEVERAGING
STABILISATION
(+ve growth, M&A up, low defaults, lending picking up)
“Our credit cycle clock currently shows the eurozone economies in the stabilisation phase – which is a supportive and benign environment for credit.”
CRUNCH
(Growth momentum fading, strong credit growth for an extended time)
(Low growth, deleveraging, defaults off the peak)
Source: Schroders. The distance from the centre indicates the strength of Schroders’ credit team’s conviction.
In contrast, the US and the UK economies are looking quite firmly in the releveraging phase, which is definitely not so bond-holder friendly. Shareholders in this phase demand far greater use of cash – and indeed management can find far more uses for it – instead of sitting on balance sheets. Mergers & acquisitions and releveraging behaviour such as leveraged buy-outs are a common feature of this part of the cycle. The worst parts of the cycle for corporate bond-holders, however, come in the bubble and crunch phases – which is where we see much of the emerging world currently.
Outlook 2014: European Corporate Bonds
EM crunch Quite how soon the crunch will really come to emerging markets is probably down to external dollar liquidity, and it may not be a 2014 occurrence. It is a real risk though, given the speed of credit growth and how these countries have benefited by having their yields suppressed in the world of quantitative easing (QE), in which money is plentiful and volatility is suppressed. If you combine this with receding fears of a eurozone break-up and underinvestment in European assets, then the outlook looks quite supportive for European markets – especially credit markets. The problem is that all bond markets and credit markets are historically highly correlated. Valuations look fair at best (and short term we see some worrying signals) and in any more taper-induced rates sell-offs it is hard to see European markets avoiding the fall-out completely (just look at what happened in May/June).
Alix Stewart Fund Manager – Fixed Income Alix Stewart started her investment career in 1994 and joined Schroders in 2012 as a Credit Portfolio Manager. Prior to joining Schroders, Alix worked for UBS Global Asset Management where she was Head of UK Fixed Interest. Earlier in her career she also worked as a corporate bond fund manager at SWIP, Gartmore and Standard Life Investments.
Further ECB easing What is clear, however, is that the European Central Bank was spooked by the recent falling inflation data across Europe and it is likely to have to do more monetary easing to reach its goal of price stability. This is at odds with the UK and US, where QE is becoming passé and central bankers are looking for a way out of it as soon as they can – without upsetting the front end of rates markets too much and choking off the recovery before it fully gains hold. While markets, therefore, can speculate on whether forward guidance calling for no rate rises before 2016 or so in both the UK and US will materialise, there is no such speculation likely in the eurozone. Credit to outperform cash That means that un-sexy returns of 2% or so this year – which should be possible in the European investment grade market for 2014 (and potentially more if you have a strong alphagenerating fund manager like Schroders) – still look decent versus virtually nothing on cash. All that leads us to be constructive on European credit markets, and by extension parts of the sterling market which still look good value comparatively, as rates risks can be hedged out. Volatility is very low currently so there will be spikes which widen spreads and provide decent entry points over the year. Should liquidity withdrawal elsewhere in the world cause more issues for emerging market economies and dollar credit, we see the European credit market as a safer haven to have your fixed income investments in. Who would have said that 18 months ago?
“In contrast, the US and the UK economies are looking quite firmly in the releveraging phase, which is definitely not so bond-holder friendly.”
Important information: The views and opinions contained herein are those of Alix Stewart, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Issued in November 2013 by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA, which is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped or monitored. w44680
