TwentyFour

After a volatile end to 2018 the European high yield market has started 2019 on the front foot, with the yield on the Euro HY Corporate Index tightening by 60bp to 4.16% since the start of the year.

January is traditionally the month of no fun. From Dry January to Veganuary, the theme is usually based on giving something up.

Friday is a big day for the US economy. We have labour market data in the form of non-farm payrolls, unemployment and average hourly earnings at 13:30 GMT, followed 90 minutes later by the ISM Manufacturing Index and the University of Michigan’s consumer confidence indicators. All of these are tier one data that have the potential to change the course of the rally we have enjoyed so far this year, for better or worse. Our view that the sell-off in Q4 2018, particularly in December, was an intra-cycle dip rather than the beginning of the end has held up, but Friday’s data dump will have a significant bearing on where we go from here.

January has been a very quiet month for the European CLO market, with spreads tightening but still relatively wide. While we know there are around 30 different CLO warehouses open – some of which are for deals that couldn’t be priced in December and were postponed – the pipeline is struggling to materialise. So far only CSAM has managed to price a new deal, and in the process showed how difficult it has become to make the arbitrage to work for equity investors (see our recent blog CLO Arbitrage Worst Since 2013).

In our latest video blog, TwentyFour CEO and portfolio manager Mark Holman discusses why markets have recovered so strongly from a difficult start to the year, and whether the rally has more room to run.

The fourth quarter of 2018 is starting to look like a distant dream for the US high yield market. In the first three weeks of this year the US HY Index (B1-rated) has produced a year-to-date total return of 3.98%, while the equivalent CCC-rated index has delivered a YTD return of 5.63%.

After a long weekend, US investors came back to a busy primary market. Despite the weaker tone, investment banks announced a handful of new deals, all of which were heavily oversubscribed and from a healthy variety of issuers.

CLO investors like to talk a lot about arbitrage, or rather the lack of it. Arbitrage is what is left of the monthly interest on the leverage loans in the CLO pool once the liabilities have been paid, and it is the main reason why a growing number of investors have been buying CLO equity in the last 18 months.

All banks’ highest quality capital is supposed to be permanent or perpetual. However, many bank regulators around the world allow banks to issue Additional Tier 1 Capital, colloquially known as ‘Coco’ bonds, as part of this capital base. These bonds are perpetual, but the bank has the option to call them after a specified period, typically five, seven or 10 years. These securities therefore tend to trade to the call date, and not to perpetuity, as investors rightly or wrongly assume that the banks will probably call and refinance these securities. The banks are under no obligation to do this, and some have said that that they would only do so if it was in their economic interest come the call date.

The year 2018 will go down in the history books as one of the most challenging we have faced in recent times, with price action in the fourth quarter being particularly brutal and difficult to respond to. When we wrote our outlook for 2019 at the start of December, we were reasonably cautious and felt it possible that prices could dislocate from fundamentals during the year, if markets started to price in the increasing likelihood of a more meaningful downturn or recession in 2020. We were not expecting this to happen in December, but it did, and it has left investors wondering whether this is the beginning of the end of the cycle, and whether months like December will be commonplace in 2019.

“…everybody’s having fun. Look to the future now, it’s only just begun.”

The dust is slowly settling after Wednesday’s FOMC rate decision, and more importantly the following press conference where Chairman Jerome Powell literally talked the market down.