Market updates

While the European bond market was setting records last week, the US market has also begun 2020 with a flurry of transactions backed up by record inflows.

Kicking off the new year, we expected the new issue market to be very active and we certainly haven’t been disappointed, with the good momentum created at the end of last year – thanks to the US and China reaching a ‘phase one’ agreement and the resounding victory by the Conservatives paving the way for Brexit negotiations to move forward – allowing pent-up borrowing demand to hit the market.

Fixed income investors are well versed in the risks of ‘fallen angels’, investment grade companies whose bonds tumble in value once they are downgraded to high yield.

The Bank of England (BoE) on Monday published its latest financial stability report and the results of its 2019 bank stress tests, and declared that the UK financial system is well prepared for even a worst-case Brexit and consequent trade war.

"One group of issuers that appears vulnerable to us as we move into a new decade is those facing increased investor scrutiny due to Environmental, Social and Governance (ESG) factors. The case of CoreCivic, a listed REIT in the US, is a good example"

Overnight markets have had significant news to digest, with two of the major geopolitical hurdles that had been worrying investors being removed.

"Where defaults get to exactly depends on a few things, but we can certainly analyse where we think the problem areas could be, whether cracks are already starting to appear, and what investors might do to protect themselves."

By now investors should be getting used to the ever more frequent hiccups in the trade negotiations between the US and the rest of the world.

Residential mortgage-backed securities (RMBS) are an under-utilised asset class for many investors, despite boasting some of the lowest default rates across the global fixed income market and offering higher yields and greater investor protections than vanilla corporate bonds of the same rating.

"In some parts of the global economy, we might be seeing a bottom in terms of low activity levels." TwentyFour's Felipe Villarroel discusses the factors behind these improving trends.

“NIBC, has been involved in ESG/CSR focused lending in Europe for some time, and is the first manager to issue what we might call an ESG CLO." Elena Rinaldi discusses why in terms of ESG, NIBC would receive a high score from us.

"We have been participants in the Additional Tier 1 (AT1) sector since its introduction in 2013, albeit with a high degree of selectivity, but the risk-reward has been obvious to us." Gary Kirk discusses the latest AT1 news from Fitch

At this late point in the cycle, fixed income investors are on high alert for signs of potential excess in the capital markets, and a proposal for potentially the biggest leveraged buyout (LBO) in history would certainly fall into that category.

The Senior Loan Officer Opinion Survey, combined with financial results from the banks, is probably still the most useful tool we have for gauging the cycle’s life expectancy.

A number of threats to risk assets have dissipated and could become positive tail risks for markets moving into 2020.

"The European CLO market is much smaller, but given the US is further ahead in the economic cycle, the US market can provide a good indication of what might happen in Europe."

For us, it is the insight into the US economy and the strength or weakness of their customers, that we find most interesting in the banking results, and especially so when the US economic data is increasingly pointing to a slowdown.

The US-China interim agreement reduces recessionary risks in both countries. However, the trade war is far from over and risks of a re-escalation persist.

It is not clear to us just how much more monetary easing will placate equity investors, and we see a real risk that when we enter the third quarter earnings season next week, company specific data from the bottom up will be more of a shock than the macro picture has been.

"We think the downside to markets is still underappreciated, and thus we would prefer to stay long protection."

The active versus passive management debate is well documented, but with ESG or sustainable investing the debate takes on a new dimension.

The globally operating travel group Thomas Cook entered liquidation this week, after it was unable to reach an agreement between its shareholders, financiers and numerous creditors, leaving hundreds of thousands of travellers stranded. A potential restructuring would likely have resulted in a significant loss for bondholders, but now it looks like the senior unsecured bonds are virtually worthless – Debtwire expects a recovery of 0-10% and the bonds are now trading at around 6 cents.

There has been a bit of nervousness to say the least in US money markets over the last few days. The overnight repo rate in dollars surged to levels not seen since the aftermath of the financial crisis, touching almost 10% on Tuesday. During the financial crisis the high dollar repo rates were a clear sign of trouble in the banking system, so it’s natural that investors might be uneasy about this. We should stress upfront that this is not the case today, the spike in the repo rate is a short term technicality created by a confluence of events, none of which should be worrisome, but in which in aggregate created a shortage of dollar cash in a short space of time and over a very short period.

At TwentyFour we regard ‘momentum’ as one of the most underestimated factors in promoting progress on environmental, social and governance (ESG) issues. Our view is capital markets should support rather than shun a company if it has a credible plan to improve in a key area or areas.