Fisch AM: Which bond segments are most interesting at the moment | Markets | 10/10/2022

The asset management shop from Zurich particularly rates investment grade corporate bonds to be attractively valued. However, there are a few “sweet spots” where the risk/reward ratio looks particularly interesting.

Maria Stäheli, Fisch Asset Management

© Fish Asset Management

For Maria Stäheli, Senior Portfolio Manager at Fisch Asset Management in Zurich, the current correction in the financial markets is extraordinary: although this has hit most asset classes hard, high-quality government bonds and investment-grade corporate bonds have seen their worst cases. scenarios so far this year. In comparison, stocks and high-yield bonds lost a similar amount in absolute terms, but are still far from their previous maximum losses (eg from the time of the financial crisis).

According to Stäheli, the reason for this development is the high level of inflation and the central banks’ correspondingly decisive battle against the price spiral, which is waged with both strong and rapid interest rate increases. Low-risk investments, which are strongly influenced by interest rates, suffered the most. Real interest rates, which have been increasing since the 4th quarter of 2021, are now having the desired effect. Long-term inflation expectations based on inflation-linked bonds, especially in the US, are on the decline. Supply chains are also being eased and, according to surveys, consumer inflation expectations are now also falling, for example in the US.

Stocks too expensive, bonds revalued at an interesting price
With its resolute action, the Fed has had its first successes and has also restored its currently tarnished credibility. However, the price of success is high, as it is likely to push the US economy into recession. This is likely to be less severe than in Europe, where the economy suffers more from high energy prices and domestic consumption is less subdued than in the US.

Against this background, Stäheli believes that current stock valuations are still too high because corporate profits are likely to come under significant pressure in the coming months. “We therefore see further significant downside potential for equity markets due to a possible combination of negative factors.”

First, earnings expectations, which are currently quite robust, could be revised down further, or the market could be caught off guard by disappointing corporate results. Second, earnings-based valuation multiples may decline at the same time due to negative market sentiment and rising risk premiums. “For high-quality bonds, on the other hand, if risk premiums react less strongly to company performance, the worst is probably over,” notes Stäheli.

Investment grade (IG) bonds worth buying
Interestingly, defensive investment grade (IG) corporate bonds currently compensate for risk much better than equities. This is proven, for example, by comparing the returns: The return on US IG Corporates is currently 5.5 percent, on par with the S&P 500 earnings return. The latter includes dividends as well as retained earnings and compares them to the share price. The situation where these very different asset classes give the same return occurred most recently during the depths of the financial crisis, when corporate profits plummeted due to the recession.

“From our point of view, this has surprisingly opened up a particularly attractive opportunity to choose a more defensive investment variant before the recession hits – and without sacrificing the high return in the process. And compared to high yield, IG Credit currently also looks advantageous : IG spreads have widened considerably more than the typical relationship to the high-yield market would imply due to high new issuance since the spring,” emphasizes Stäheli.

Stable fundamentals
Fundamentally, US IG companies are in very solid shape and are well positioned to handle the expected macro headwinds. Recent years’ extremely high growth in sales, profits and margins act as a buffer against rising raw material prices and labor costs. In addition, their leverage and available liquidity are generally stable. This is reflected in positive rating momentum, where every downgrade is matched by 2.5 upgrades.

In Stäheli’s view, these securities will survive a recession scenario much better because of the high quality of the borrowers and the associated lower sensitivity of credit premiums.

European corporate bonds riskier – reverse search Yankees
Stäheli, on the other hand, sees more fundamental risks in the case of European IG issuers. Debt ratios are thus rising while profit margins are falling, especially when discounting the strong energy sector. Because of this discrepancy, however, US bonds are also more expensive.

Stäheli therefore considers the spreads and returns in the EUR IG Corporates market to be favorable, especially if the US dollar alternative were to be hedged, which is currently very expensive. “That’s why we currently identify EUR bonds from US borrowers (so-called reverse Yankees) as the sweet spot, because here we currently find ‘the best of both worlds’ – solid fundamental development and cheap risk premiums at the same time. “

Economically favorable
At the sector level, Stäheli currently favors financial stocks, which have significantly underperformed non-financials since the beginning of the year. The additional premium over industrials is unusual at almost 40 basis points. Their fundamental position also appears solid, with profitability improving as interest rates rise as long as yield curves are steep. Both their credit quality and capital base are also stronger than they were before the pandemic, and the stress tests of recent years show that European banks in particular have become more resilient. In addition, the banking sector within the IG bond universe naturally has a shorter duration, which reduces interest rate sensitivity. So being overweight seems sensible at the moment.

“Overall, this presents a number of attractive opportunities for high-quality corporate bonds after this year’s sharp correction. And when central banks make the long-awaited change in direction, we expect IG’s long duration to outpace any falling interest rates.” , emphasizes Stäheli In conclusion. (aa)

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