La Française AM, positive outlook for high yield in 2021
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Key takeaways: - Favorable fundamental and technical factors for Global High Yield market - Performance should mainly be driven by carry - Caution on Emerging Market issuers
During S1 2021, the high yield bond market outperformed the investment grade segment. This movement was driven by a set of positive factors: the substantial drop in default rates, especially in the US, extremely accommodative central bank monetary policies and the strong performance of fallen angels. (Source: La Française AM, BoAML, data as at 31/05/2021)
The cautious stance on emerging markets in the global strategies of La Française AM has paid off as performance in the region was substantially hindered by China where corporate defaults and stress ratios stood at their highest for many years. (Source: BoAML, data as at 30/04/2021) That being said, the outlook for the high yield market for the remainder of 2021 remains positive as both fundamental and technical factors remain strong. “The global high yield market significantly outperformed the global investment grade market by more than 400 basis points. Year to date, the performance was 3.3% for high yield (denominated in euros) compared to -1% for investment grade”, said Akram Gharbi, Head of High Yield Investment at La Française AM. For the remainder of the year, La Française AM forecasts that performance will be mainly driven by carry as spreads continue to fluctuate within a relatively narrow range. Any market stress resulting from a change in central bank policy will most likely be short lived and could provide an attractive market entry opportunity.
“For Q3, we expect global high yield spreads to move within a range of 320 to 360 basis points. And any spread widening beyond 360 basis points because of rising concern about the delta variant of Covid-19, could represent a good buying opportunity. We remain confident in global economic recovery and central bank support”, said Gharbi.
Alternatively, experts at La Française AM anticipate struggles in the private lending sector. “Lufthansa, for example, as a listed company has access to the market. Private companies, however, will struggle for lending. Therefore, we expect to see a high increase in default rates in private lending, but not in the high yield market”, said Gharbi.
Inflation, not here to stay
La Française AM does not expect a lasting return of inflation and believes the recent appreciation in the US consumer price index (CPI) to be temporary as due to cyclical factors. “We are not afraid of inflation”, said Gharbi. For inflation to be a long-term risk, the production capacity needs to be destroyed by a long-term collapse in global supply (surge in corporate defaults). The absence of inflationary risk should keep interest rates low and central banks should maintain accommodative monetary policies. At the current time, it is more appropriate to talk about short-term price adjustments which are typical in a recovery phase”, commented Gharbi.
Outlook on the second half of 2021
La Française remains positive on High Yield for the next six months. Several reasons support this optimism. Firstly, corporate fundamentals in the US and Europe remain strong and the global economic recovery should continue until the end of the year and beyond. Therefore, default rates should stay low in these regions (below 3.5% in US, stable at around 2% in Europe). Secondly, technical factors are still favorable to the asset class and there is still value to be found for investors looking for a stable coupon over the next few years. Gharbi is confident: “High Yield is the only market in the liquid fixed income space where you can find a 3% net yield.” And finally, most of the performance for the rest of 2021 should come from carry as spreads will likely remain within a range of 320 and 360 basis points.
Opportunities outshine risks
The short-term risk will likely be linked more to flows rather than fundamentals, i.e., a change in central bank policy, mainly the Fed. “At the moment, economic recovery in the US is gaining speed and may induce the Fed to adopt a less dovish stance. I do not think the Fed will put an abrupt end to its accommodative policy, but they could draw some liquidity from the market which might create some volatility. But that is not a game changer for us”, argues Gharbi. The mid-term risk could be linked to the political situation in Europe, as there will be elections in Germany and France which could generate some volatility in the market. The most significant mid-term risk according to La Française AM is related to the health situation in Emerging Markets, as the number of COVID-19 cases continues to increase in these regions. “In terms of regions, we still prefer Europe and the US and see value and good opportunities in the primary market with issuers like Triton Water, Allied Universal and Douglas, just to name a few”, said Gharbi.
La Française AM continues with its cautious stance on the Emerging markets. “We are not planning to increase our exposure to emerging markets in the short term as we think the situation could get worse before getting better”, said Gharbi. In terms of ratings, La Française AM still sees value in “BB” rated issuers operating in sectors related to COVID-19, such as airline companies and industrials, some of which have only recovered 70 % of their spread widening compared to almost 100 % for “BB” rated companies operating in sectors unaffected by the pandemic. “Therefore, we expect the rally to continue in this part of the market”, concluded Gharbi.
This commentary is intended for professional investors within the meaning of MiFID II. It is provided for informational and educational purposes only and is not intended to serve as a forecast, research product or investment advice and should not be construed as such. It may not constitute investment advice or an offer, invitation or recommendation to invest in particular investments or to adopt any investment strategy. Past performance is not indicative of future performance. The opinions expressed by La Française Group are based on current market conditions and are subject to change without notice. These opinions may differ from those of other investment professionals. Past performance is not indicative of future performance. Published by La Française AM Finance Services, head office located at 128 boulevard Raspail, 75006 Paris, France, a company regulated by the Autorité de Contrôle Prudentiel as an investment services provider, no. 18673 X, a subsidiary of La Française. La Française Asset Management was approved by the AMF under no. GP97076 on 1 July 1997.