02 December 2021
Omicron value creation
As the new Omicron strain of the virus has taken hold of markets, we assess whether this has created an attractive buying opportunity for developed credit markets.
Fundamentals
The latest coronavirus strain, Omicron, has been the key driver of markets recently, with the World Health Organization labelling it as a “variant of concern”. We are still in an information vacuum though, with more questions than answers at this point. The coming weeks will tell us whether, compared to the Delta strain, Omicron is more or less severe, the relative degree of transmissibility and if vaccines are as effective. From an investing perspective, governments’ responses to Omicron will determine the potential impact it could have on credit fundamentals, which so far have not been affected. Despite this new uncertainty, investment grade and high yield corporates are in good shape. Balance sheets are strong, having reduced leverage levels and extended maturity profiles of existing debt. Meanwhile, default rates currently stand at 0.4% in the US and 1.0% in Europe and we expect these low levels to persist through next year. Overall, the foundation of the economic recovery and expansion are on solid footing and so long as the ensuing Omicron data does not force renewed lockdowns, we expect a favourable environment for credit.
Quantitative valuations
The information vacuum is not good for asset prices over the near term. This is evident in the recent move wider in credit spreads. US investment grade spreads are now back in line with where they started the year at 103 basis points (bps), while in Europe spreads are 18 bps wider at 111 bps. While European high yield spreads are now also higher than the start of this year, the US hasn’t quite reached that level. Regardless, they widened 47 bps and 51 bps respectively in November which is the largest move since March 2020. Clearly some value has been created. The question though is whether or not current levels pose an attractive opportunity. First, headlines and narrative most likely need to shift for price buoyancy to return and second, investors also need to factor in switching costs if thinking of moving into more risky assets, as offer levels won’t paint as rosy a picture as bid side prices will – for instance, European high yield has a yield of 3.11% using bid prices but 2.55% using offer prices.
Investment grade and high yield credit spreads saw their largest monthly move since March 2020
Source: Source: Bloomberg, ICE indices (HUC0, HECM, C0A0, ER00); data as of 30 November 2021. HY= high yield, IG= investment grade. RHS = right hand side.
Technicals
If anything, the recent spike in volatility may end up helping buoy credit technicals as supply may be hindered in an already slow month from a seasonal perspective. Usually, the last couple of weeks of December tend to be slow in terms of new issues, but we are expecting that the supply slowdown has now been brought forward somewhat. On the other hand, demand for corporate credit, and risk in general, going forward is likely to be contingent on the level of uncertainty posed by the virus. Overall in November, high yield saw outflows to a tune of roughly $4 billion in the US and €200 million in Europe, whereas investment grade saw inflows of $426 million in the US and €5.3 billion in Europe. For investors considering taking advantage of improved valuations across these markets, they should also bear in mind lighter liquidity in December.
What does this mean for fixed income investors?
At this point, all we know for sure is that this new variant brings with it a level of uncertainty in the near term. As new data starts to fill the information vacuum, we will learn what situation we are in from a public-health perspective and, importantly, what actions governments take. Thus far, beyond the travel bans, it does not appear that developed market governments are inclined to risk restricting mobility. Instead, they have taken the stance of using Omicron as a reason to emphasize the importance of vaccination and boosters. Both positive and negative outcomes are still very possible at this juncture and as such we do not think indiscriminate buying of credit is the right call. However, providing policy reactions do not veer towards national lockdowns, with credit fundamentals still in good stead, there are pockets of value which appear more attractive now and we think investors will benefit from a more selective approach in the current environment.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum
0903c02a82aa386b20211203