Credit’s steep rally means it’s now time to play defense, money managers say.
(Bloomberg) — Credit’s steep rally means it’s now time to play defense, money managers say.
Previously bullish analysts are changing tack after a sharp rally left few assets looking like good value, while central banks are continuing with their hawkish message on interest rates and inflation as economies remain more resilient than expected.
“Risk markets seem to be pricing a soft landing scenario — I think the market is a bit too optimistic,” said Kshitij Sinha, a portfolio manager at Canada Life Asset Management. “We have moved and are moving to a more defensive stance with an allocation toward high-quality defensive names that can see through an earnings recession.”
Credit prices have soared since October as traders bet that central banks will stop rate hikes at a lower level than previously expected. After buying in at the lowest prices in about a decade, certain investors are abandoning risky bets because the gains since then have shrunk the bond premiums so much that they no longer compensate enough for a potential decline in companies’ health.
“The low hanging fruit has been collected,” said Maria Staeheli, a senior portfolio manager at Fisch Asset Management. “It has been evident for the past couple of weeks” that opportunities in new issues in particular “are getting very close to fair value.”
In the aftermath of the European Central Bank’s meeting last week, JPMorgan Chase & Co. strategists led by Matthew Bailey wrote that the rally “may be sowing the seeds of its own destruction,” as it could prompt a strong response by the ECB. After four months of calling for tighter spreads, the strategists now suggest hedges and recommend taking profit in long-dated and junior debt.
Rating companies are also raising the alarm. Fitch Ratings said in a recent report that “trends point to downside risk for global corporate ratings,” while S&P Global Ratings warned on Tuesday about financing pressure from the pandemic-era debt overhang.
Early evidence of a slowdown in corporate earnings is coming to light as consumers tighten their belts due to the higher cost of living. About 42% of companies on MSCI Europe have missed earnings-per-share expectations as of Feb. 7, about 10 percentage points more than the previous earnings season, based on data compiled by Bloomberg Intelligence.
That’s despite earnings expectations being set lower for this quarter. Analysts were only expecting earnings growth of about 11% this time, compared with 32% in the previous season, meaning more firms are failing to cross a smaller hurdle.
To be sure, credit fund managers have been receiving inflows for almost four months straight, giving them enough cash to bid for bonds. Orders have outweighed the size of new private-sector issues in Europe’s syndicated bond market by almost four times in February, based on data compiled by Bloomberg.
The surge in demand means the sweeteners that companies offer to lure those investors — known as new issue concessions — have shrunk this month to about half their January levels. For some investors, this is further evidence that value is becoming harder to find.
Still, the gains in credit markets since mid-October have taken down risk premiums in high-grade euro debt almost 100 basis points to 141 basis points, near the lowest since April. In sterling, premiums have also tumbled 100 basis points to 160 basis points, according to Bloomberg indexes.
On Wednesday, more bulls moderated their views. HSBC Holdings Plc strategists Song Jin Lee and Jonathan White moderated their stance on sterling credit as spreads no longer “overcompensate” investors for cyclical risks.
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