Credit market leaders and laggards in the coronavirus sell-off

The value in credit is becoming more obvious. Few if any companies or sectors have been immune to the pain of the extremely rapid recent sell-off in credit spreads. Even the more resilient or defensive sectors have weakened significantly. The same goes for the credit spreads of the emerging market (EM) countries.

That said, as the dust settles on an extraordinary few weeks we can see that markets have at least made some distinction between different sectors and countries. In global high yield (HY), there has been a material dispersion in the performance of sectors.

Which high yield sectors have suffered the most?

Figure 1 shows the change in the option-adjusted spread (OAS) since 31 December 2019 for the best (dark blue) and the worst (light blue) performing sectors of the Bloomberg Barclays Global HY Index.

Unsurprisingly, the spreads of the airlines have increased the most, as the global aviation industry has come to a halt. Airline spreads have widened by 1440 basis points (bps), narrowly eclipsing the carnage in the energy sector.

Other hard hit sectors are mostly related to the consumer – leisure, gaming, retail and restaurant sectors have all seen spreads widen sharply as countries have gone into lockdown. Wider spreads mean investors are getting paid more to lend companies money, but also reflect the fact that investors see increased risk.

At the other end of the scale, the sectors that are less impacted by the virus, for example food and beverage, supermarkets and utilities, have significantly outperformed the HY index. These non-cyclical sectors usually fare better in recessions, even more so in the current environment where most people have had to cut down the consumption to necessities.

A sector that stands out is banking, which has outperformed the index. Banks, especially the ones with a non-investment grade rating, could be vulnerable to sudden economic disruption. The relative calm of the HY bank bonds illustrates how banks are now much safer than in 2008, or at least perceived to be so. The central bank response has been fast and substantial so systemic risk should be low, however, within the riskier part of the market individual companies could still be vulnerable. 

How does the recent spread sell-off compare to previous periods of stress?

Unsurprisingly, the spreads are more elevated in sectors that have seen the greatest spread widening, but this relationship is not uniform. If we compare the current worst performing sectors to the 2008 Global Financial Crisis (GFC), only airlines, energy and tobacco[1] have spreads wider than in the GFC. In some sectors, the spreads are close, while in gaming and restaurants, the difference is still quite pronounced.

Among the best performing sectors, financials have spreads far below the GFC peak. For example, in the banking sector, the current spread of 697bps pales in comparison to the GFC peak of 2843bps. In the typical non-cyclical sectors, the spreads are still far from the GFC peak. Whether the market has correctly identified these industries as more resilient, or they see additional widening should the situation deteriorate, remains to be seen. 

How has emerging market corporate credit performed?

In EM corporate credit (Figure 2), the situation is similar, although with some notable exceptions. Transport is the worst performing sector, driven again by the demise of the airlines. Metals and mining, an important sector in a number of EM countries, has also been hit particularly hard. In stark contrast to developed markets (DM), the performance of the oil and gas sector has been almost on par with the index. This is because a lot of EM energy companies are either state-owned or have the implicit backing of the state, meaning that it is unlikely that they will be allowed to default.  

As is the case with the DM credit, the typical non-cyclical sectors have outperformed. For example, the spreads in the utility and infrastructure sectors have widened less than the index, while financials have also fared relatively well.

Significant dispersion among EM sovereign debt

Finally, we look at EM sovereigns in Figure 3. The worst performing country, Ecuador, was in trouble already before the coronavirus situation escalated and has seen its spread increase by thousands of basis points. There have been calls in Ecuador to default on the bonds and direct the funds to fighting the virus.

A number of African countries have also seen the spreads of their US dollar bonds widen sharply, though the region has been so far less affected by the coronavirus. The spread widening in Angola, Gabon, Ghana and Cameroon can be explained largely by the oil price crash.

In addition, many of the worst performing credits are illiquid, even under normal circumstances, so the extreme illiquidity of the last few weeks will probably have exacerbated spread moves. The upside is that the spreads of the HY part of the EM sovereign market are now look extreme, even when compared to the GFC.

Most eastern European countries have weathered the storm rather well. These countries usually benefit from lower oil prices. Russia, even though an oil exporter, has also done relatively well. 

While Saudi Arabia, UAE and Kuwait are clearly suffering from the sharp oil price drop, the spreads of the

sovereign bonds of these countries have not blown out much, as large foreign currency reserves provide a cushion.

In summary, credit spreads have widened significantly, but are not yet at historically wide levels in most sectors and countries. The areas of the market that are driven by the oil price fluctuations and the situation in the aviation industry have seen the spreads widen by more than thousand basis points. These sectors and countries now offer opportunities for high risk-tolerance investors.

On the other hand, the sectors that have fared better, and EM countries that are less vulnerable, are not yet trading at extreme valuations, highlighting the intricate trade-off in the credit market.