Outlook 2016: Global Corporate Bonds
We expect corporate bonds to outperform government bonds in 2016 although investors should brace themselves for periods of heightened volatility.
22 December 2015
The themes driving risk assets1 globally have shifted dramatically over the course of 2015 and should continue to do so next year.
However, we believe that corporate bond markets should generate positive excess returns versus government bonds over the next twelve months, albeit with periods of extreme price volatility.
In our view, the following key themes will have a significant impact on credit markets globally:
- Growth should remain modest by historical standards for major developed economies
- Divergence in central bank policies will be a source of volatility. Importantly, we do not believe that a tightening cycle by the Federal Reserve (Fed) will result in an adverse reaction by risk assets.
- Emerging market economies will remain in the headlines. Despite the situation in China, we expect the trend of economic activity in many emerging economies to stabilize and even improve as we progress through the year.
- Corporate credit fundamentals vary by region and industry but should broadly remain stable. The credit cycle is much further advanced in the US than in Europe or the UK, but we do not see deteriorating fundamentals triggering a dramatic re-pricing of risk globally.
- The supply of bond issuance, which has been a major contributor to wider credit spreads during 2015, primarily in the US, should abate somewhat and become more supportive for valuations.
2015 has sown the seeds for a volatile 2016
China, and the potential contagion from its economic slowdown, have been and continues to be a major issue which must be confronted by investors.
In spite of the initiation of a quantitative easing (QE) programme by the European Central Bank (ECB) late last year, the economic picture in the eurozone remains rather fragile.
The persistent Greek drama, a refugee crisis not seen on the continent since the Second World War, multiple terrorist incidents and even a reassertion of more “nationalistic” tendencies all pose long-term challenges to Europe’s political union.
Not to be outdone, the US has also embarked on the presidential election season which promises to add further volatility to markets.
Fortunately, these events have yet to shake the confidence of businesses or consumers.
However, we are vigilant of catalysts that could lead to a change in sentiment and will continue to focus on these and future developments that may impact credit markets in 2016.
US dollar markets
Looking to 2016, we believe that US dollar credit markets offer attractive valuations, and the economic picture continues to be among the best of the developed economies.
We see the bank and finance sectors as representing lower risk than the broader market.
In the energy sector, we also believe a number of companies in the investment grade2 universe – those with attractive assets and fairly good balance sheets - are currently valued as high yield credits.
We spent much of 2015 very cautious of emerging market bonds, both sovereign and corporate, but this caution has receded in recent weeks.
We see higher quality sovereign credits as offering a more attractive risk-reward profile than emerging market corporate bonds.
Finally, US high yield bonds3 have become more compelling during the last three months of 2015.
While we have generally avoided the energy and basic materials sectors - which we perceive to have significant default risks in the coming year - we look more favourably upon higher quality issuers.
Euro bond markets
The euro denominated corporate bond market looks to be among the more challenging of the major markets to decipher as we enter 2016.
While the ECB’s QE programme is arguably supportive of risk assets in the eurozone, much of this appears to be fully reflected in valuations.
Frankly, it is very difficult to be overly enthusiastic about a broad market that yields well below 1.5%.
Similar to the US, the underlying economic fundamentals in the UK are reasonably sound, and valuations are more attractive than those in the euro denominated markets.
Sterling corporate bond markets often pose challenges in terms of liquidity, but on balance we believe that some exposure could be warranted.
Research remains essential
2016 should prove to be an interesting year for global credit markets as we continue to digest the events of the past year and their impact on the overall fixed income landscape.
As we enter the year, the Fed has embarked on its first rate hiking cycle in over a decade.
China will try to find its footing, while oil attempts to rebound after reaching a low not seen since the financial crisis.
There will certainly be many significant decisions to be made and we anticipate that the coming year will be another opportunity for us to capitalize on market dislocations.
While price volatility will undoubtedly be with us for the foreseeable future, we are confident that opportunities exist and that, with research, investors can uncover specific industries and issuers that offer attractive value amid this challenging credit environment.
1. Risk asset: Generally refers to assets that have a significant degree of price volatility, such as equities, commodities, high-yield bonds, real estate and currencies.↩
2. Investment grade bonds: The highest quality bonds as assessed by a credit ratings agency. To be deemed investment grade, a bond must have a credit rating of at least BBB (Standard& Poor's) or Baa3 (Moody's).↩
3. High yield bond: A speculative bond with a credit rating below investment grade. Generally, the higher the risk of default by the bond issuer, the greater the interest or coupon.↩
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