The European corporate bond market is in a state of cognitive dissonance. Thanks to a dovish ECB, average European investment-grade spreads rallied to their tightest levels of the year last week - at swaps plus 83bp according to the iBoxx euro non-financials index - while the primary market has seen yields get crushed and deals multiple times subscribed.
But some investors say they are feeling bearish and are buying bonds simply because they have to.
“Nineteen out of 20 investors are bearish on credit spreads,” said one DCM syndicate banker, “yet every deal is amazing.”
Take Schaeffler, for example. Less than two months ago, the German auto parts company said it would cut 900 jobs, shut plants and reduce its product range after 2018 earnings slumped due to weak demand in Europe and China.
But on Tuesday investors could not get enough of its new issue. The €2.2bn deal was more than eight times subscribed, with investors placing some €18.5bn of orders.
Another blowout that caught the eye last week was a €3bn four-part deal from Spanish motorway group Abertis to refinance its acquisition by a group including Italy’s troubled Atlantia. The offering, which comprised three euro bonds and one sterling tranche, got €16.25bn-equivalent in orders.
It was an astonishing result, especially as Atlantia’s purchase made Abertis the most highly leveraged name in the European toll road space.
“It’s very tough to be an investor,” the syndicate banker said. “All of them got slapped last year, and all of them are fearful of underperforming the index, their peers and their colleague sitting next to them.”
HANDS TIED
Despite growing fears about corporate leverage, weak earnings and poor economic growth, many investors feel they have their hands tied.
After beginning the year underweight credit, fund managers have a lot of money to put to work not only thanks to new inflows but also because expected redemptions from their funds never materialised.
And so now investors are desperate not to miss out on a potential rally - despite the warning signs.
“Some [investors] do feel the need to chase the corporate bond benchmark - which means you can’t have too much of a cash balance or risk-free products like Gilts or Bunds,” said Gordon Shannon, a portfolio manager at Twenty Four Asset Management.
Indeed, part of the problem for credit investors is a lack of alternatives.
Credit still compares favourably with cash - the ECB’s deposit rate is -0.40%. And 10-year Bunds are not much better at close to zero.
“Some euro investors would do anything to avoid showing negative yields on their holdings - which is harder and harder as more of the Bund curve is negative,” Shannon said.
One strategy investors are adopting is buying at the short end and going up in credit quality, giving weight to the idea the recent rally lacks conviction.
Several investors have told IFR they are having problems with picking up short-dated bonds in both primary and secondary, such is the demand.
“People are scared, but they don’t know how long they have before the thing that they are scared of happens,” Shannon said. “That’s what keeps you invested, and that’s when you get bearish buying.”
SENSE OF UNEASE
Both the ECB and the US Federal Reserve have been sending dovish signals in response to weakening economic data - the Fed by signalling that a rate hike this year is no longer likely and the ECB with its latest TLTRO liquidity extension.
But while those actions have sent credit rocketing in the short term, they have accentuated a sense of unease that central banks are running out of ammunition.
“Sustaining the rally probably requires a big improvement in fund flows and investor appetite,” Citigroup analysts led by Matt King, global head of credit products strategy, wrote in a recent report.
“For all its strength, the rally has been marked by a distinct lack of enthusiasm.”
Some investors are hanging their hat on the idea that the ECB could resuscitate its corporate bond purchase programme if the market really takes a turn for the worse.
In a show of hands at Citigroup’s European Spread Products conference last month, investors thought “central banks would be forced back towards outright easing, with the ECB even being forced to buy corporate bonds again before year-end”.
But most investors IFR spoke to agreed that for the CSPP to return, the market would first have to go through a lot of pain.
Investor gloom is by no means a universal opinion in the market, of course.
Many investors feel they have good reason to be bullish.
“We are in a very strong environment for credit markets globally,” said Andrey Kuznetsov, senior portfolio manager at Hermes Investment.
“More supportive monetary policy, better than expected fourth-quarter earnings, and stabilisation of macroeconomic data in Europe vis-a-vis expectations all support the fundamental backdrop for credit.”
