The original renaissance was a cultural movement that lasted from the 14th to the 17th century and is regarded as the cultural bridge between the middle ages and modern history.
The latest renaissance was evident at the recent SALT investment conference in Las Vegas. Among the reasons cited were lower P/E ratios, higher dividend ratios, lower interest rates and lower political risk. The comparisons were all made relative to the US market. We have been making these observations for some time now. And we again note that macro surprises in the US are turning negative while they remain positive in Europe.
European Leveraged Loans
The ECB published its guidelines for leveraged lending capping leverage at six times which brings it into line with US regulations. Senior leverage has crept up to five times in Europe but equity contributions are much higher than pre-crisis as is interest rate coverage. However, in the end credit is a game of fundamental bottom up analysis and, despite benign macro, interest rate and default forecasts, investors need to do their borrower homework. With this caveat in mind, the asset class still offers compelling relative value, in particular in the CLO market.
Yellen and gang have unanimously agreed an approach to balance sheet normalisation. The normalisation will be phased in with reinvestments in MBS and USTs ceasing on a gradually increasing basis but subject to caps so that the process is controlled. Street estimates for normalisation are capped at $300bn over four quarters or $25bn a month. This normalisation is expected to start in the fourth quarter of this year and is estimated to be equivalent to 35bps of policy tightening. It comes on top of a Fed fund rate hiking cycle which we are six months into.
Remember when quantitative easing started in November 2008? Nine years later and it is now ending. Of course it could restart if the economy sputters but the more immediate concern is what misallocations of capital will be revealed as this monetary tide starts to creep out?
Fossil Fuels and Renewables
Oil slumped 5% despite OPEC agreeing to an extension of production cuts. Coal trading has brought an experienced energy trader in Asia to its knees. At the same time the unsubsidised solar and wind costs fell below the costs of fossil fuels last year. They are expected to fall further and advances in large scale battery electricity storage are also being made. This all begs the question of what the energy and grid industry, which is a big hungry consumer of credit, will look like 5/10/15 years from now.
China Two Speed Economy
Did you know Ray Dalio posts thoughts on LinkedIn? Will retail focused asset managers advertise on Snap Chat and Facebook one day? While reading his post what caught our eye was his description of China. He said “aggregate conditions are the net of “two economies” that look very different: a slowing, heavily indebted “old economy” with pockets of excess capacity, and a steadily expanding “new economy” driven by higher-end industries and household consumption”.
China (like the US) is tightening monetary conditions this year. How her two micro-economies interact with each other and the outside world will be relevant for global investors.
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