Investors in the European corporate bond market are sitting on a pile of cash that will be reinvested in the market after the expected frenzy of activity in the new issues market in September failed to materialise.
September is traditionally one of the busiest months of the year in the primary market, when the investors and borrowers return from the summer holidays. But supply this month has reached just €5.3bn – less than half of the €14bn issued in the same month last year. Issuance this year is expected to fall 10 to 15 per cent short of the €100bn raised last year. The low supply of new issues compared with high redemption and coupon payments from existing issues is giving investors excess cash to invest.
“Technical factors are very supportive of credit spreads. Long-term investors withdrew exposure to the market in August, expecting to re-enter via the primary market in September. But the heavy supply hasn’t materialised,” says Robert McAdie, global head of credit strategy at Barclays Capital.
“Redemptions and coupon payments from corporate bonds in the euro market will exceed €30bn in the second half of the year, far outstripping supply. History tells that the vast majority of redemptions and coupons are reinvested in the market and this will leave investors with a pile of cash that will have to be put to work in the secondary market.”
The supply and demand imbalance will support credit spreads but analysts point out that it cannot withstand a change in sentiment.
“Favourable technicals will support credit spreads but only as long as company fundamentals are positive,” says Mr McAdie.
Fundamentally, corporations remain in good health. Strong balance sheets have driven default rates to historic lows. Modest economic growth and the combination of low interest rates and government bond yields helped the market recover as strongly as it did after the sell-off from March to May.
This positive picture should continue to boost the corporate bond market but many investors sound increasingly nervous, wondering whether this is as good as it gets.
Partly the risks are sectoral. Gloom surrounds potential bankruptcies in the automotive and airline industry and high oil prices are likely to hit retailers as well as other companies further up the supply chain as consumer spending slows.
Analysts will be looking at impending third-quarter results of companies to assess the impact of the prolonged period of oil prices above $60 a barrel since the summer.
“The third-quarter earnings season will give us an indication of how much energy prices is hitting cost bases and how much of that companies are able to pass on to consumers,” said says Suki Mann, credit strategist at SG CIB.
European investors also suffer from the continued lack of an ability to unhitch their investments from the economic fortunes of the US, according to Raja Visweswaran, head of credit strategy research at Banc of America.
“For now, exports remain concentrated on the US at the high end and Asia at the low end. So, if the US were to go into a cyclical downturn, then Europe would follow,” he says.
Mr Visweswaran has a neutral view on the credit environment but believes that the market is fully priced with all the risk on the downside.
“The market is at fair value with very little downside protection,” he says.
Such credit events include ratings downgrades, or the effects on spreads of further leveraged buyouts. Mr Visweswaran says the likelihood of buyouts remains strong. With low interest rate expectations keeping funding costs down, private equity groups have access to large amounts of money. Hedge funds also have become more active in buyouts.
As long as companies are able to generate excess cash flows to fund their spending, corporate bond spreads are likely to be supported. But current valuations mean the stakes are higher. “If you have an event now, the market would be much more volatile because investors are already accepting less compensation,” says Mr Visweswaran.