Market updates

It has been a positive sign for us that despite lockdowns being enforced in most of the major economies around the world, in the last two weeks several issuers have managed to successfully raise new debt via the primary market.

After a period of material weakness in spreads and general market stress, the common ingredient to recent corporate bond spread stability and subsequent strength has been the resurgence of the primary market.

Having started the year with low yields and tight spreads, fixed income markets had the most brutal month I can recall in March and have been repriced in the most aggressive manner imaginable. The dust does appear to have settled and a more balanced market without ‘fire sale’ pressure has returned, so we thought it was worth recapping where we are today and sharing some thoughts for the journey ahead.

As a manager that invests across the full spectrum of fixed income, we are constantly monitoring the relative value of the different opportunity sets that we cover. Given the fast moving prices we have witnessed recently, and with different asset classes and ratings moving at different times, this analysis can become increasingly valuable.

In response to the exceptional circumstances brought about by Covid-19, the Prudential Regulation Authority (PRA) at the Bank of England has written to UK banks asking them to ‘consider’ appropriate action regarding the payment, accrual and vesting of variable remuneration (i.e. bonuses) for senior staff, together with any dividend payments or share buyback plans.

In the last two weeks we’ve looked at how CLOs behaved during the global financial crisis, and we’ve stress tested a current CLO with GFC-like defaults to see where individual tranches would start to take a loss in that scenario. Keeping in mind the rule that the third in any trilogy is usually either the best or the worst, let’s hope this third instalment is more Toy Story 3 than Tokyo Drift.

With central banks and governments pumping huge amounts of funding into their domestic economies, they are obviously very keen that companies act with prudence and look after their surplus cash sparingly, by cutting back on distributions such as dividend payments and any share buyback plans.

At any other time, record issuance and record outflows in US investment grade would each be worthy of attention. Given the havoc COVID-19 has wreaked in recent weeks, it would be tempting to write off these milestones occurring in parallel last week as merely the latest quirk of an unprecedented period for bond markets, but the reasons behind this apparent sentiment split are worth keeping an eye on.

After a considerable period of zero activity new issue bond markets have reopened this week with a flurry of deals in the US and now in Europe. As usual it has been frequent high quality borrowers reopening the marketplace, and they have done so with confidence from their syndicate bankers that attractive pricing will result in successful transactions.

Clearly this shock/stress test is a severe scenario, but given the uncertainties that COVID-19 has thrown our way, as debt investors we would rather be overly conservative.

Some of the panic selling has also abated as investors are gradually building their cash piles to desirable levels. However, we are still a long way away from normal bond markets.

Yesterday we blogged on how European HY had always led recoveries in UK equities this century, and that even more so this time around we expect the same to happen.

With markets in turmoil and economies around the world shutting down to slow the spread of COVID-19, many investors have been looking to the US to lead the stimulus effort on both the monetary and fiscal policy front. This week they may have got it.

In the last two weeks we have seen savage falls in risk assets, but with the unprecedented stimulus and support action taken by policymakers globally, many investors’ minds have inevitably turned to when risk assets might be a buy again. More specifically, given equities are higher beta assets in multi-asset portfolios, when should asset allocators be buying equities again?

In the case of Aareal Bank the management decision is understandable in our view; should the market panic and begin to offer extended AT1 bonds at a heavy discount, then investors could see this as a real opportunity over the medium term.

For participants in financial markets a liquidity squeeze that lasts for a prolonged period is one of the most difficult environments to cope with. Correlations break down, markets trade in a vacuum, small trades lead to disproportionate price moves, relative value goes out of the window, panic sets in, selling is indiscriminate. This is where we have been for the last two weeks. So we thought we would share some of these experiences with you and try to rationalise why it is happening and when it might end.

In recent weeks we’ve seen significant sell-offs across all asset classes as investors have been scrambling for liquidity. With most of Europe and the US effectively in lockdown, a recession looks to be inevitable and the question is what this will do to corporates’ ability to service and refinance their outstanding debt, especially for those in the sub-investment grade space.

RMBS bondholders should not fear lenders accommodating borrowers’ short term needs for an extended period of time.

The authorities are now rapidly promising huge aid packages, but how do these aid packages find their way to the people that need aid? This is what is missing

In the last few days the World Health Organisation has declared COVID-19 a global pandemic, the Italian government has imposed a nationwide lockdown on 60 million people, and President Trump has banned all travel to the US from Schengen Area European countries for 30 days.

We noted with interest two headlines yesterday: Italy to suspend mortgage payments amid outbreak and RBS and NatWest offer mortgage breaks for customers affected by coronavirus

Our take on all of this is that the central bank has acted in a very targeted and timely way, adding large volumes of liquidity at even lower rates, along with significant capital to the banking system.

Monday was one of those days investment professionals will remember all their lives, and compare with similar standout days from the past.

Companies, even earnings pressured ones, now need to seriously consider the negative impact on their long term cost of capital from short term decisions to shore up P&L.