The future of the corporate bond market is the subject of heated debate between fund managers. Some ...
The future of the corporate bond market is the subject of heated debate between fund managers. Some declare its current strength will continue, others claiming the downturn is just around the corner.
The primary reasons given for optimism about the credit market in the US are the better standards of corporate governance that have developed their over the past few years combined with a strong institutional demand for the asset class from the big pension funds. On the other side, the doom-mongers point to weak fundamentals, stating that the technical drivers of the market will only support it in the short term.
However, all of them agree that spreads between corporate and government bonds are at historically low levels, especially in the US, where spreads are at their tightest since 1997.
Keith Swabey, client portfolio manager with JP Morgan Fleming, is very upbeat about the future of this asset class. He believes there will be strong US economic growth next year, supporting the credit markets.
He says: "Over the last two years companies have reduced the amount of debt on their balance sheets, the risk has been declining and the default rate in the market has fallen from 4% to 1%."
Neil Sutherland, fund manager with Axa Investment Management, disagrees with Swabey. He expects credit spreads to widen versus government bonds, especially at longer-dated maturities, where an increase in risk aversion could cause the credit curve to steepen.
"The fundamentals still remain remarkably benign for the corporate sector, with default rates falling globally and cash balances at 30-year highs. With companies reluctant to spend cash, there seems to be a complacency entering the market," he says.
He adds that global fixed income and especially corporate bond markets have been driven by technical factors rather than by fundamental factors this year.
But in the end it is the fundamentals that determine market performance and so the long-term outlook for corporate bond market is therefore poor.
Both Swabey and Sutherland agree that, for US-based companies with large overseas operations, a weaker dollar would be a positive for their credit profile, and a negative for non-US companies exporting into the US.
Sutherland thinks that a disorderly decline in the dollar and a corresponding rise in inflation would have a positive impact on fixed income investment because rising inflation helps deflate a company's debt burden.
Swabey feels there is no significant difference between the US, UK and European markets. He further adds that in terms of market direction the three geographical blocs are very highly correlated.
Sutherland disagrees. He thinks Europe is the most expensive in spread terms with the US market trading the cheapest. The UK market is defensive and biased towards the finance sector. European and US markets on the other hand are more exposed to cyclical industries such as auto makers.
According to Kevin Cronin, deputy head of investments at Putnam Investments and Sutherland, investors should be cautious in 2005. The willingness of companies to engage in financial actions friendly to shareholders but unfriendly to bondholders is a major obstacle that the market will have to deal with. And the declining dollar rate will be a hurdle that the market will have to overcome in order to remain steady.
On the positive side, Kronin expects a greater dispersion of returns among individual credits and industries. In the US, he is enthusiastic about sectors including media and cable companies, non-office REITs, wireless providers and chemical companies, but pessimistic about the fortunes of car manufacturers, banks and brokerage firms and credit card issuers.
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