What lessons have you learned from 2016?
The big lesson is not to underestimate the power of the popular vote and that capital markets can be inured to some of the more unusual decisions of the electorate.
With Brexit there was a worry that markets would struggle but the Bank of England reacted expediently and in line with other central banks that were going through programmes of quantitative easing (QE). Given the solidity in markets, and the injection of liquidity, investors were happy to retain exposure to credit markets.
The election of Donald Trump as the next US President was a different type of result – he was able to generate in a week the increase in the yield curve that central banks had been trying to engineer for several years. Where there is an injection of money and liquidity there will be a reason to be involved in capital markets.
What key themes are likely to shape credit markets in 2017?
2017 is likely to be dominated by central banks, politicians and the popular vote, allied to the amount of liquidity left in capital markets given that central banks are buying a lot of the available bonds. That said, we have been pleasantly surprised at how much liquidity has existed on the buy and sell side – the levels are quite encouraging.
The high yield market will be dominated by security selection. Investment grade credit is likely to be dominated by what happens to government bonds and where yields go, so investment grade may offer more value later in the year but there will likely be an adverse impact on total return as yield curves rise. Clearly some of the events of 2016 will play out more fully in 2017.
What are your highest conviction positions moving into the new year?
These depend on the geographical markets and where we are on the ratings spectrum.
For example, in terms of what Trump means for US investment grade credit, his presidency could be positive for some areas – a more upward steeping yield curve and less regulation would be good for financial institutions. In terms of European high yield, we are in a good part of the credit cycle – companies are still reasonably disciplined – and the bonds offer a decent yield pick-up over local government and investment grade bonds so they could be inured to what is happening in the interest rate space. In terms of European investment grade, with a small amount of spread there is some concern about what a repricing of government bonds will mean for total return. As to emerging market corporates, investors do not always realise that this is mainly an investment grade market and it is offering some decent yields across a whole spectrum of countries and corporates.
What should investors expect from the asset class?
As I say every year, investors should expect some volatility, but this is particularly pertinent in 2017 given the shape of the yield curve and where countries are in the credit cycle. There may be some sharp movements in prices and spread.
It is likely to be a year of taking the carry – the income from a bond. This is because when you balance the potentially negative impact from rising government bond yields against potential spread narrowing due to improving corporate fundamentals, you will likely end up somewhere between those two factors, i.e., a return akin to the running yield.
Outside of that, it depends on how different the political parties in various countries operate and who is voted in. If we get any extreme policies coming through that could create more volatility, but in general I think we could see a policy effect that is quite positive for corporate credit.