European high yield bonds have had a disappointing past 18 months with spreads over German bunds exc...
European high yield bonds have had a disappointing past 18 months with spreads over German bunds exceeding 1000 basis points recently. But, looking forward, the market is set to improve.
From a macro point of view, since November 1999 the European Central Bank has raised rates from 2.5% to 4.75%. Higher rates are expected as the ECB attempts to combat inflation, which has been fuelled by the weak euro and high oil price.
However, there are already signs of slowing activity, which suggest rates should not go much further, especially when the direction of both the oil price and, apparently, the euro are out of the ECB's control.
Obviously, the euro needs to strengthen from its current levels for the good of the global economy. However, the weak euro is benefiting exporters from Europe. Next year, the ECB has forecast growth in excess of 3%, which is relatively strong considering the volatile environment, and it is likely that Europe will at last take over the running on growth from the US which will be attempting a rather difficult soft landing.
One reason for the widening of spreads is due to the substantial issuance in the past year, mainly from telecommunication-related companies. In order to get their issues away, companies had to offer the market higher and higher coupons.
A further reason for spreads widening was the volatility within the equity markets, particularly associated with technology stocks.
Over the summer, adverse newsflow within the telecom sector exacerbated the negative sentiment built up during the tech market correction. When reporting results for the second quarter of 2000 Ericsson and Nokia met the market's earnings expectations.
However, Ericsson reported losses in its handset division due to company specific issues, while Nokia forecast lower numbers for the third quarter of 2000, again for company specific reasons. In addition, Asian manufacturers began talking down total handset sales for 2001 as Korean sales plummeted after subsidies were removed. While news items such as these went across the screens, the third-generation mobile licenses were being auctioned across Europe. The sums being paid for these licenses went beyond all estimates and began to be a cause for concern in themselves.
Reflecting the equity market over the year, telecommunication-related bonds are down about 20%. In contrast, industrials have produced a positive return.
While the equity market has reacted negatively to newsflow regarding telecom companies during the summer, thus affecting bond prices, strong fundamentals remain in place.
Head bonds have risen following an upgrade to B, after the company raised $240 million in an IPO offering. Other good performers have included Kappa and Weightwatchers.
Paul Reed is head of fixed interest at Aberdeen Asset Managers
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