Global Weekly: No December déjà vu

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The year-end is drawing closer and markets seem to be fairly calm. However, there might still be some market-moving news in the offing, related to, for example, the trade war or the UK elections. Having said that, the current market situation is in stark contrast with last year’s Christmas period, when markets were taking a deep dive on the back of recession fears.

This week, equity markets started off on a positive note after the US job report offered a clearly stronger picture than anticipated. As a consequence, especially the more cyclical parts of the market were favoured, which is similar to the picture we have seen over the fourth quarter so far. This underlying trend is in stark contrast with the second and third quarter, when investors were clearly more cautious and predominantly focused on defensive quality companies.

On a company level, there was relatively little news. On the positive side, Sanofi announced to end the search for take-over candidates in diabetes and to focus more on oncology therapy. In addition, Spanish fashion retailer Inditex surprised positively with higher-than-anticipated sales growth and better margins. On a more negative note, Home Depot signalled a softening of the US housing market, leading the home improvement retailer to slightly lower its 2020 growth outlook. Nevertheless, with an expected top-line growth level around 4%, Home Depot is still entering the new year in an upbeat manner – and managing expectations before the start of the year is very often a rewarding strategy.

Bonds – through the mid-cycle correction

Both the trade war and Brexit are at critical crossroads again. Although these specific geopolitical tensions will not entirely disappear anytime soon, they might stabilise. In that case, the positive turn in macro leading indicators we have witnessed recently could become more pronounced. Any change in the balance of risks is quickly picked up in bond markets and has already put yields on an upward trajectory. For the time being, however, we think that this spike is overdone, as these positive macro signals are still soft. In addition, monetary easing is still likely to dominate bond market developments in 2020, even though the Fed did not lower its rate this week. Shifts in the balance of risks could force us to adjust our view on fixed income, particularly related to our overweight in duration.

Corporate bonds continue to be supported by the ECB, as the central bank started buying these bonds again in November. This protective shell has made risk premia for these bonds come down. However, this year, euro-denominated corporate bonds were printed at turbo speed, at EUR 27 billion a month on average. The ECB’s monthly buying budget is only a fraction of that. As a consequence, a decrease in demand for these new bond issues could easily stir up the corporate bond market. The soundness of these bonds is therefore still related to a further strengthening of the economy. Other bonds, such as high yield, should benefit indirectly from the ECB’s asset purchase programme.

Risk premia in high yield and emerging market debt (EMD) have benefitted from recent positive developments. EMD saw some spread widening in areas with political unrest, mostly in Latin America. High-yield markets have performed well recently. However, they now look more vulnerable to us, with investor protection (covenants) at decade lows and the differences in risk premia within the universe heating up. Some 8% of high-yield bonds are ‘distressed’ (meaning that yields on these bonds are higher than 10%), and recently this is no longer restricted to the lowest-rated bonds. We have seen in the past that if more than 10% of high-yield bonds are distressed, this can lead to a capitulation of this market.