11th January 2016
Mark Dowding, partner & co-head of investment grade debt at BlueBay Asset Management gives his latest view on the markets…
Renewed fears with respect to financial stability in China have weighed on financial markets, with the Renminbi trading to new lows, as Beijing struggles to ease policy to support growth and support asset prices at the same time.
Meanwhile, oil prices have reached new lows at US$32 per barrel, adding to the stress on producers, shown by Saudi CDS trading up at 190bps, wider than a BB rated sovereign such as Portugal.
Core government bond yields were lower over the week, as markets moved in a risk-off direction and inflation projections were revised lower in response to lower commodity prices.
Eurozone Consumer Price Index surprised to the downside at 0.2% year-on-year in December and with the European Central Bank (ECB) having projected US$50 oil at their last meeting, evidence already suggests that ECB inflation forecasts may need to be cut again in March, which may open the door to speculation with respect to further monetary easing.
US data appears more robust, shown by auto sales at an 8 year high as the US consumer continues to benefit from a positive income shock from lower energy prices. However, soft ISM Manufacturing Index prints have seen Q4 growth projections revised lower, with the Federal Reserve Bank of Atlanta projecting a disappointing 1.0% over the quarter.
Against a risk-off background, credit markets have been under pressure at the start of the New Year and spreads have widened. At a sectoral level, retailers have been under some pressure as the march of online discounters such as Amazon continue to eat market share and raise the threat of insolvencies in the high street.
Commodity names have also traded down with higher quality names in the energy sector, which have continued to trade close to par up to this point, coming under pressure as oil threatens to fall below US$30. Sovereign spreads have also widened, failing to keep pace with the rally in Bunds and Treasuries.
In emerging markets, currencies have been under renewed pressure with Mexico, South Africa, Russia and others trading to new lows as the US dollar continues to appreciate.
However, the strongest performer last week was the Yen, which has benefitted from a flight to quality and receding hopes for additional monetary stimulus until the next fiscal year.
Looking ahead, near term focus will be on Friday’s US jobs report. However, beyond this it seems that events in China will be disproportionately important in determining the near term direction for markets.
Economically speaking, Chinese GDP would appear relatively stable, with Chinese consumer growth supporting overall economic activity.
In addition, as the world’s largest importer of commodities, China is a clear beneficiary with respect to lower prices. Yet we believe policy uncertainty could lead to a further loss of confidence in markets and in the short term it seems difficult to predict how domestic markets will continue to react.
Away from China, the backdrop for growth in the major developed economies looks relatively stable, with a more benign inflation outlook suggesting more dovish central bank policy. That said, we come into 2016 with a sense of ‘more of the same’ in financial markets.
In terms of our views, we have little conviction with respect to directional trades in core rates and currencies for the time being.
We believe that there is value in some areas of sovereign and corporate credit and maintain a net long beta position, but we believe that it is important to be discerning in terms of name selection.
We only want to maintain exposure to issuers with a stable or improving credit profile having seen how stories with deteriorating newsflow continue to be disproportionately punished with wider spreads.
In this context, picking the losers in 2016 may be as important as picking the winners as the asymmetry of returns means that there is material alpha to be generated by identifying weakening credit stories.
In line with this thinking we have been actively adding more short risk names in the Strategy, in order to move corporate credit beta exposure closer to flat. Dispersion of returns should be an important theme in 2016 and we feel it will be important to focus on fundamental analysis in order to identify where to invest both with respect to long and short exposure.
Apparently 2016 will be the Chinese year of the Monkey, suggesting opportunities for the intelligent, quick witted and crafty. Perhaps this is cheerful to know, for those who feel like the first week of the year has already been a bit of a pig!