- We are looking optimistically into 2020 and forecast stable to slightly tighter spreads. We will centre our investments on investment grade (IG), non-cyclical credits, banks, subordinated bonds and Asian credit.
- Strong support, in particular, from the European Central Bank (ECB) and the Federal Reserve (Fed) makes us more optimistic for credit returns in 2020.
- Besides credit, we expect interest rate risk to be an important topic in 2020 as the global macroeconomic environment continues to stabilise, possibly causing rates to go up and negatively impact total returns. However we believe an active approach to global credit that generates positive credit excess returns will best mitigate the impact of increasing rates.
2020 global credit outlook
Compared to now, global credit portfolio decisions back in January look easy. Economic numbers were still reasonable, valuations were cheap after the Q4 sell-off and central banks had exited the markets, leaving the markets undisturbed by their bond buying programs. At the beginning of the year we decided to position the portfolio with a positive view for global credit markets. Now, after a strong rally in 2019, we have scaled back risk in our portfolio and harvested the majority of profits toward the end of the year. The important question now is, what comes next? The global credit markets certainly feel more complicated at the end of 2019 than they did at the start of the year. Macro-economic data has weakened significantly, while spreads have tightened, tilting valuations from cheap to expensive. Nevertheless, central banks and their renewed quantitative easing programs, as well as lower rates, have anchored tight spreads even as fundamentals have weakened. Strong support, in particular, from the ECB as well as the Fed makes us more optimistic for credit returns in 2020. But how will we position our strategy for the coming year?
We are going to focus on the investment grade (IG) sector and stay cautious on speculative grade credit. We have already seen that the weaker economic environment has taken its toll on some companies which led to an increase in speculative grade default rates and credits, trading at distress levels. Central bank support will help the broader market but not fix broken business models. When we invest into speculative grade issuers, our investments are centred on stable BB-rated credits within non-cyclical sectors. This part of the market looks expensive but we think it has the potential for further appreciation, as solid credits with yield pick-ups that are attractive relative to IGs are still in demand.
Flexibility in portfolio construction will also remain our top theme, as we will continue to control market risk in the portfolio with CDS markets. Superior liquidity compared to the bond market enables portfolio management to quickly adjust risk in the Nikko AM Global Credit Strategy.
Within the IG universe we remain overweight in non-cyclical sectors (i.e. telecommunications, utilities) as well as banks. Non-cyclical credits are often more focused on domestic markets and are therefore shielded from the trade war and the subsequent economic weakness. However, after a weak year for cyclical trade-oriented credits, value opportunities are emerging. Most auto manufacturers are taking the right steps in reducing costs, adjusting production levels and investing in future technologies. Spreads of some of the highly-rated issuers now look attractive.
In addition to non-cyclical issuers and some occasional opportunities in trade oriented credits, we still favour banks, even as the low-rate environment is expected to continue negatively impacting their profitability. Nevertheless, the capital ratios of most banks still offer solid support for their credit profiles. Furthermore, as leverage is picking up for a large number of non-financial credits across the globe, banks are still reducing leverage, or at least keeping it stable, and therefore present a more defensive play than non-financials.
Other investment themes that will dominate our positions will be an overweight of subordinated credits as well as opportunities in Asia. In the non-financial as well as the financial universe, we are comfortable investing into subordinated bonds of solid IG issuers and harvest the spread pick-up these bonds offer over senior bonds. In particular, non-preferred senior (NPS) bonds of European banks present an appealing opportunity to increase portfolio yields.
Including Asian credits in the portfolio offers multiple benefits. First, the region’s bonds are lower in volatility as their duration is often lower relative to their developed market peers. Adding Asian IG issuers therefore helps reduce interest rate risk, even as their spreads are comparable to most European and US issuers. The second reason is the region’s strong domestic buyer base, with around 80% of all new issues bought by local investors. The latter gives strong support to the segment even when volatility is on the rise. Finally, we expect most Asian economies, in particular China, to show economic stability in 2020. Our investments will focus on highly rated state-owned enterprises (SOE).
Overall, we view 2020 with optimism and forecast stable to slightly tighter spreads. We will centre our investments on IG, non-cyclical credits, banks, subordinated bonds and Asian credit. We will also add BB bonds as well as automotive issuers. Besides credit, we expect interest rate risk to be an important topic in 2020 as the global macroeconomic environment continues to stabilise, possibly causing rates to rise and negatively impact total returns. However we believe an active approach to global credit and positive credit excess returns will best mitigate the impact of increasing rates.