As sovereign yields in Europe continue to slide to unprecedented lows, many investors have become sceptical on whether value can still be found on the continent. However, by looking further afield than the more common peripheral names such as Spain and Italy, we at T. Rowe Price have found a number of outposts still offering investors scope for returns.
For example, we currently have a bullish view on the sovereign debt of Slovenia, Iceland, Lithuania and Romania. T. Rowe rates Slovenian debt at BBB, directly comparable to Italy and Spain, yet the yield of Slovenian bonds is considerably higher than for comparable maturities for both Italian and Spanish bonds (see table below). We believe Slovenian yields could converge to same level as Spanish and Italian yields within the next 12 months, for a number of reasons.
Potential for rating upgrade
Slovenia is already rated A- by S&P, but continues to be rated below investment grade at Ba1 by Moody’s – a gap of four notches between the two agencies. We expect Moody’s to upgrade Slovenia back to investment grade, possibly at the next review, which should be a strong support for the bond market.
Real GDP growth has been surprisingly strong since the end of 2013. We expect growth to be in the range of 2%-2.5% in 2014, accelerating to close to 3% in 2015, making the country one of the fastest growing in the Eurozone.
Slovenia has undertaken a strong reduction in its fiscal deficit over the past two years. It is improving its economic metrics at a time when we are not seeing many inroads from the likes of Spain and Italy. Further fiscal consolidation is expected, with Slovenian government debt/GDP net of deposits expected to stabilise below 70% and the budget deficit likely to reach 3% of GDP by 2015.
Political stability remains a concern; however, on the encouraging side, we note the new government’s economic programme is anchored by European Commission recommendations. There has been progress on the privatisation programme.
Other compelling opportunities
Outside of Slovenia, T. Rowe has tended to invest opportunistically in a number of Baltic names, and we currently have a positon in the higher-quality bonds of Lithuania. In addition, we also see some interesting investment opportunities in Iceland and in Romania, particularly in euro-denominated bonds. We feel these countries are a good substitute for the more conventional allocation to countries such as Italy and Spain, where fundamentals have scope to deteriorate further and where recent performance has been driven more by flows.
|17 Sep 2014||Moody’s/S&P/Fitch||5-yr yield (euro-denominated debt)||10-yr yield (euro-denominated debt)|
[i] Economic data source: IMF, Eurostat and T. Rowe Price September 2014
Kenneth Orchard, T. Rowe Price’s portfolio manager of European Fixed Income