Markets – Emerging value
June closed the first half of the year with a volatile touch. The month has been one of the worst months on record since March 2020, with equities down 8-10%, and high yield credit down 7-8%. Rates started the month wider but then quickly tightened again as markets re-priced recession fears and chances of cuts in 2023. Overall, we start seeing value emerging in the broad credit space. CDS indexes in US and Europe imply annual default rates in the order of 8-10%, well above recent rates and in line with extreme economic scenarios. Investment grade issuers have re-priced meaningfully, and pay yields at multi-year highs, thanks to the combination of yield re-pricing and spread widening. Cyclical issuers start paying yields that discount heavy stress probabilities, despite solid fundamentals. In Europe, Intesa AT1 now pay 13% (to call). In the US, Carnival senior bonds pay 15%. In recent weeks, the selloff in credit has been amplified by low liquidity, so valuations offer an extra premium. Markets can remain choppy a bit longer, but we think credit valuations start offering value. Current levels of spreads have materialized infrequently in the past and have historically been associated with strong multi-year returns. Chances of a broad-based slowdown are higher than a month ago, but arguably broadly priced. The June selloff has thus broadly corroborated our view that it is time to dip toes in credit markets, as volatility can persist but levels start offering value to long-term investors.
European inflation – Mixed signals
European inflation prints for June offered mixed signals to investors. At European level, the print came in line, at 0.8% MoM and 8.6% YoY. Cross-country differences have been meaningful, though. Spain and Italy strongly surprised on the upside (with Spain registering a record high 10.8% increase), driven by further increases in energy costs. Germany surprised on the downside, as government subsidies on transportation costs kept prices in check. France delivered a CPI print roughly in line. In general, most items in CPI basket are still rising, especially among services, but all prints show some stabilization in good prices. Some stabilization in energy will thus be sufficient to deliver inflation easing in September, as bottlenecks easing on the goods side is already apparent. Current data, however, do not show signs of an upcoming cliff so that the ECB will need to keep a hawkish tone until some easing is baked in the data. The July meeting is likely to deliver a 25bp hike and stronger guidance for next meetings, in line with the message out from the Sintra conference last week. PMI data were weak but still above recessionary levels. New orders were low across the board suggesting a further cooling in economic activity after summer.
Algebris Investments’ Global Credit Team
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