Review and Outlook
European high-yield bonds, as measured by the ICE Bank of America Merrill Lynch (BofA ML) Euro High Yield Constrained Index,1 returned 1.39% in April, bringing their year-to-date return to 6.76%. Global risk assets continued their strong rally in April, supported by dovish global central banks, positive trade headlines, generally positive corporate earnings reports, improving macroeconomic data and low volatility. Investor sentiment was buoyed by strong economic data from China, as well as growing hopes for a successful trade deal between China and the U.S. Oil rallied as the U.S. government stated that it would no longer give buyers of Iranian oil a waiver from sanctions. Additionally, the broader U.S. equity market S&P 500 Index2 hit a record high in late April. In the UK, Brexit uncertainties were postponed for six months to October 2019. In a market where issuance has been low and there is a general shortage of bonds, the spread on the ICE BofA ML Euro High Yield Constrained Index tightened 27 basis points (bps) 366 bps in April. Towards the end of the month, the rally stalled somewhat as investors’ attention turned to a new-issue market that finally kicked into life.
In Europe, economic data were more mixed, with the IHS Markit Eurozone Composite Purchasing Managers Index (PMI) and Germany’s IFO Business Climate Index posting generally lower-than-expected readings, and auto sales remaining relatively weak. According to J.P. Morgan, the data suggest that underlying growth in the region is stuck barely above 1%, once a payback from numerous “one-off” drags from the second half of 2018 are excluded.3 In terms of public companies, the first-quarter 2019 earnings season has remained broadly supportive, with 53% of European companies beating expectations, by an average of +3%. However, the cyclical sectors continued to underperform the market’s expectations, with 80% of materials, 58% of consumer discretionary, and 52% of industrials companies missing earnings estimates.4
The International Monetary Fund (MF) lowered its global economic growth forecast for 2019 to 3.3% from the previous level of 3.5% in its World Economic Outlook published in April. The IMF is projecting a decline in growth for 70% of the global economy for 2019. U.S. inflation data or March 2019 was generally disappointing, which we feel reinforces our view that Federal Reserve monetary policy remains on hold despite improving macroeconomic data.
According to a recent survey conducted by Bank of America Merrill Lynch, investors are generally positioned for low growth and low interest rates, with 70% of respondents expecting a global recession to start in 2020 or soon thereafter.5 The vast majority do not believe the recent U.S. Treasury yield curve inversion signals an impending recession and they feel that the top two tail risks are a trade war with China and an economic slowdown in China.
We are not surprised that the European economy is lagging the momentum that is gathering elsewhere globally, especially in the U.S. and China. Europe tends to subsequently echo the growth of these economies as we saw in 2017 (strong to the upside) and 2018 (far weaker than expected). WE believe that Europe should be able to produce low growth that is adequate for the majority of issuers in credit markets. The exception is those weaker companies that require a strong growth tailwind to deleverage.
1 The ICE BofA ML Euro High Yield Constrained Index tracks the performance of euro-denominated below-investment-grade corporate debt publicly issued in the euro domestic or eurobond markets. Indexes are unmanaged and are included for illustrative purposes only. You cannot invest directly in an index.
2 The S&P 500 Index is an unmanaged index considered representative of the U.S. stock market.
3 Source: J.P. Morgan, April 2019
4 Source: Bank of America Merrill Lynch, April 2019
5 Source: Bank of America Merrill Lynch Fund Manager Survey, April 2019
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, as well as political and economic risks. These risks are enhanced in emerging-markets countries.
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