First light at the end of the tunnel
12 August 2008
Value exists for investors in the credit market, especially amongst financial issues, despite the likelihood that overall credit spreads may remain high for some time, according to analysis published today by leading investment house, Standard Life Investments.
In the latest edition of Global Insight, its monthly investment view, Standard Life Investments examines the outlook in the credit markets in the wake of the global credit crunch. It identifies the latest drivers and predicts the likely outturn into 2009 using its Focus on Change methodology.
Roger Sadewsky, Investment Director, Fixed Income at Standard Life Investments, said:
"Performance in the corporate bond markets will reflect developments in both the wider economy as well as the financial system. Our House View concludes that global economic conditions will stay challenging in the medium term. Central bankers are grappling with an unusual combination of weak economic growth yet elevated consumer inflation. A period of sub-trend growth is required, beneficial both in terms of reducing inflationary tendencies within the major economies as well as enabling a more rational allocation of capital through purging the leveraged excesses of recent years.
"Secondly, the global credit crunch is one year old. Looking ahead, investors need to see confidence restored in both the wider financial system and some key components, for example the credit rating agencies. Although commercial and investment banks are recapitalising, which is undoubtedly good news, they will be unable to embark on major lending programmes for some time. Corporate bond issuance could therefore periodically be high.
"A key Focus on Change question is whether these issues have already been discounted adequately in the price of credit. In general terms, the bond markets will re-price when some element of stability returns to both the macro-economic and the corporate environments, allowing the large risk premium in credit to fall back. Our House View certainly does not expect a rapid recovery for the global economy. The likelihood of weak economic data or further negative surprises from individual companies is high. Nevertheless, the credit markets appear to have already priced in a large amount of the bad news. Although overall credit spreads may remain at elevated levels for some time, there is value, in particular in the financial sector. Conversely, our analysis concludes that the incremental return from investing in high yield bonds is marginal. They contain more implicit default risk than investment grade debt, due to the more leveraged nature of the companies involved, thereby making this asset class particularly sensitive to ongoing economic stress."
