(Bloomberg) -- The era of a rising tide lifting all boats in the global credit market may be over.
Analysts at Goldman Sachs Group Inc. and BNP Paribas SA are forecasting the end of a rally that has turned the world’s credit market into a uniform mass of expensive assets. They recommend taking a more defensive stance and positioning for the gap between safer and riskier debt to widen.
The call follows a surge in credit that has compressed the extra juice funds get from holding lower quality bonds to nearly its lowest level since the global financial crisis. That’s left some investors feeling they are not being compensated for a myriad of risks from policy uncertainty and deteriorating economies to geopolitical tensions.
“With spreads at the tighter end and growth looking below trend with certain elements of uncertainty, it is prudent to remain at the higher end of the credit spectrum,” said Dillon Lancaster, a portfolio manager at TwentyFour Asset Management. “In corporates, spreads don’t make a bunch of sense to be reaching down.”
Billions have been pouring into funds that invest in corporate bonds, driving gains across the board. Bank of America Corp. said there were “buyers galore” in its latest report on European credit, while the bank’s US investor survey showed a record share of respondents expecting inflows into high-grade funds over the coming months. BNP Paribas thinks rate cuts will favor safer debt.
“The catalyst is flows. During rate-cut periods, funds flow from the short end, such as money markets, into high-quality fixed income. Hence flows favor high-quality outperformance,” said Viktor Hjort, global head of credit strategy and desk analysts at BNP Paribas.
Spread Decompression
Right now there is little difference in the risk premium between global corporate bonds rated single A and those at triple B — just a few steps above junk. This gap has been squashed to near the lowest since 2008, according to Bloomberg indexes. That leads Hjort to see it widening, or “decompression,” as investors demand more for lower-rated debt.
It’s a similar picture looking at euro-denominated credit. That leaves only a “meager” spread pick-up for the riskier category, according to Goldman Sachs.
“A more defensive posture within the EUR market is increasingly warranted,” strategists led by Lotfi Karoui wrote in a recent note to clients. “We recommend positioning for decompression within the IG rating spectrum as well as between BBBs and BBs in the EUR market.”
They argue that a widening economic growth gap between the US and Europe is making the cyclical industries in European credit a more precarious investment, and hence these sectors should be offering greater yields.
Major European carmakers have been the poster boy of this angst in recent weeks. A series of profit warnings, coupled with concerns about growth in their home markets and China, have fueled losses that have weighed on returns for the high-grade index as a whole.
Still, indicators of corporate health are not flagging any red signals, underlining why the market is treating riskier credits more in line with better-rated debt.
The ratio of average net debt compared to earnings among European firms remains near its lowest on record, according to Stoxx indexes. And the US companies that have already reported third-quarter earnings have beaten analyst expectations overall, based on data compiled by Bloomberg.
The narrow gap between ratings “is a reflection of tight spreads,” said Gilles Pradere, a senior fixed income manager at RAM Active Investments. “Levels are tight but not out of touch with fundamentals,” he said.
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