Mark Dowding, partner & co-head of Investment Grade at BlueBay Asset Management gives his latest view on the markets.
Post-Fed price action last week was dominated by fears that downside risks to the global economy are growing, leading to a renewed rout in emerging markets and risk assets in general.
The Chinese Caixin PMI, at 47.0, did little to lift these fears in a week where there were few other significant data releases of note, though Yellen’s testimony last week restored some calm as she reiterated that the economic outlook remains robust and that the Fed continues to expect to start hiking rates before the end of the year.
In hindsight, the FOMC may have done a lot better by opting for the ‘dovish hike’, though in reviewing price action in markets in the past several days it seems much of what we have witnessed is investors expressing a degree of fear and uncertainty, rather than reacting to new information.
Consequently we continue to look for markets to regain their poise and for the environment to turn much more constructive on risk assets in the days ahead, although we are aware that downside risks related to a loss of confidence in global policy makers is a rising threat in a bear market case.
These market fears were also not helped by the news from VW last week. Revelations that the company has been found falsifying emission figures on a grand scale has left investors fuming. With speculation that costs associated with the scandal could rise towards $20bn, the credit worthiness of one of the most rock steady stalwarts of the Euro corporate bond market has been badly impacted, with CDS spreads rising from 75bp to 220bp in the matter of 3 days.
That this should happen in such a conservative and seemingly well managed company has shaken investors ability to trust all corporate management. In a sense, if VW is found to be deliberately cheating, then who can you rely on?
With this additional uncertainty coming at a time of heightened nervousness and thin market liquidity, this has consequently contributed to a marked rise in spreads.
The past week has been a very difficult one with respect to strategy performance. As we have been communicating over the past several weeks, we have been adding risk in corporate and sovereign credit and in currencies with the view that markets would perform well following the Federal Reserve meeting.
We believe that spreads should rally, with monetary policy remaining relatively dovish and we continue to look for additional monetary easing from the BoJ and the ECB prior to the end of 2015.
We also believe that current fears with respect to weaker global growth and a hard landing in China are materially over-exaggerated.
Consequently, with markets selling off in the past several days, this has led to negative returns with losses in corporate bonds, sovereign credit and fx only partly compensated by gains with respect to a long interest rate duration exposure in German Bunds.
As a result of the price action, we have pared some positions in liquid instruments, by reducing long risk positions via CDS indices in credit and by reducing exposure to currencies such as the Mexico peso by a half, based on a stop loss discipline.
However, we have not materially changed our view and on an idiosyncratic basis we have actually sought to add risk in names such as VW (where we had no position previously in the strategy), where price action looks unjustified and inconsistent with the underlying fundamentals.
There are a number of reasons to maintain an optimistic stance on risk assets at this point. Growth in the US and eurozone seems to be just above 2.5% and 1.5% respectively and on a global basis, GDP in 2016 is likely to be higher than was the case in 2015. The Fed remains on course to raise rates gradually and in many regards, the weather looks set fair, especially with the BoJ and ECB more likely to ease policy in response to low levels of inflation in our view.
Most fears at present seem to centre on China, yet we are hopeful that CNH and SHCOMP shown signs of calming down close to 6.40 and 3,000 respectively. Commodity prices remain above their lows and in Brazil, where the currency has been collapsing and credit spreads have been exploding, we believe that bearishness may also be close to overdone.
Fears related to Petrobras and its ability to refinance its $110bn worth of debt are understandable, with corporates across the country seemingly losing market access. However, with the sovereign still sitting on $300bn of currency reserves, there is plenty of scope to restore confidence if there is any evidence that policy makers choose the right path going forward.
In this context we remain structurally bullish, notwithstanding the difficult market backdrop and choose to retain relatively high levels of risk in the Strategy consistent with our conviction in this view. Nevertheless, we have been seeking to hedge downside risks by participating in out of the money call options on government bonds on the view that the principal risk scenario to our central view does not seem to be strong data and a hawkish central bank, rather weak data and fears of a global recession.
It has been a messy few days and following price action in the week ahead will be important as we don’t wanted to be pig-headed in our views, lest policy makers leave us gagging.