Pre-Christmas Sales in the Credit Markets
The same approach needs to be taken with the credit markets which are closing at the year’s lows across the board. We think there is fundamental value at these levels (as measured by the default adjusted risky credit spread). However, we are mindful that defaults have been unusually low over the past years. We are also mindful of the weak technical structure of the market which is the result of large investor outflows hitting a market maker inventory that has been reduced in this business cycle by regulations. There is also a slowing global economy to contend with. We are therefore taking a cautious approach to deploying cash balances and selectively buying the lines of credit assets we think represent the best value.
European high yield is looking attractive at these levels on a multi-year basis but also relative to US credit and the leveraged loan market. This is the first time we have seen value in this market on an asset allocation basis in two years. The CLO team is also in the fortunate position of having dry powder and unused warehouse lines. This is because they took a cautious approach to ramping up assets in the CLO portfolios as the arbitrage narrowed through the latter part of the year (see Snapshots CLO Arbitrage – 7 September).
Migration was a key political issue over the course of 2018 in Europe, the UK and the US. We think migration will be a key credit issue in 2019 as slowing global growth and earnings result in rating downgrades in a cyclically leveraged corporate market. In particular, there could be a transition of BBB investment grade securities to crossover high yield securities. This has been well flagged in the press.
It is unclear what the default picture will look like in the securities markets due to the covenant light nature of the market. However, tighter capital market liquidity will mean some borrowers will not be able to refinance next year.
We also expect continued volatility in financial assets and real estate asset prices as the support from Quantitative Easing policies continues to ebb away.
Happy holidays and good luck for 2019.
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