In a quiet week for IPOs in Europe, Dr. Sebastian Raedler, Head of European Equity Strategy at Bank of America Merrill Lynch asks whether investors can find any value left in the market; as growth has accelerated, he argues they need to ask which growth scenario is currently priced into the market to assess that potential.
Barnaby Martin, head of European Credit Strategy at BofA Merrill Lynch says that with an expected €600 billion raised by corporates this year, companies may have gone too far. Supported by central bank activity many are now sitting on more than a year’s worth of earnings, and high yield is really the only market in which investors can find strong yields.
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Dan Barnes Welcome to Primary Markets TV in Europe, Middle East and Africa – Your update on newly issued securities. I’m Dan Barnes. Europe is far quieter than Asia Pacific for IPOs this week. On the LSC this month, we’re expecting to see the listing of diagnostics firm Abingdon Health, date as yet unconfirmed, and that will be on the AM market. It also saw the listing of Helium One Global, read for last of the price of 4.50 pounds a share. We continue to see a lot of bond issuance reported to the LSC many with sub-one percent yields with 20-year bonds from Nestlé and BP capital markets recently. In the rates space also, UK MP’s are challenging the price of UK government bonds being issued to market, suggesting that investors might have paid more than the price set that was indicated to banks recently. The FTSE has the story; most of deals going into the market have been snapped up at the highest price point, indicative of deep investor appetite. MP’s have requested a response from the debt management office. Euronext saw the IPO of video-on-demand firm Alchemy the week before last, on the Euronext growth market at a price of 16.20 euros. Last week on the Oslo Börs, which is also part of Euronext, Meltwater was issued – a provider of media, intelligence and social analytics software-as-a-service. That was admitted to trading via the Euronext growth platform on Oslo Börs. in Spain the BME welcomed ASPY GLOBAL to its growth market on Friday; the 9th company to list on demand growth this year. It also issued a 650 million euro bond trading from SIX Group, the 0% coupon, and a yield to maturity of 0.009% maturity in December in 2025. The issue is 4.2 times oversubscribed. SIX Group of course actually BME for 2.8 billion euros this year. I’m joined now by Dr. Sebastian Raedler, head of European Equity Strategy at Bank of America Merrill Lynch. Martin Barnaby, European Head of Credit Strategy at Bank of America Merrill Lynch. Guys, welcome to the show.
Both Thank you.
Dan Barnes Sebastian, if I could start with you. There’s been a lot of hope for recovery from the COVID-19 shock, which has already been priced into the equity market after a strong rally since March. What does this mean for equity investors?
Seabstian Raedler Well, the key question that investors now have to ask themselves after a 40% rally from the lows in March, ‘is there any value left?’ The clients we spoke to at the beginning of the year, they were very worried about the outlook and there were many reasons not to engage with the rally. People were telling us in April and May. that unemployment is going to rise. Defaults are coming in, in Barnaby’s space (credit strategy). So, the uncertainty is very high, and yet the market has done what it always does. The big trap that people typically fall into is: if they don’t look at the rate of change, they look at the level. That means at the bottom of the market, when growth is very weak, they’re very concerned. And then at the top of the market, when growth is very strong, they’re very bullish. What has happened is growth has accelerated very strongly, the market has risen, and we now have the ironic situation where the rally has continued – because in Europe, because of the lockdowns, the second wave of the virus – growth momentum has slowed and the market has simply said, ‘I don’t care because I know this is temporary. I know the vaccine is coming.’ And so the best way that we have to quantify it, and to answer the key question, ‘is there some value left,’ is to ask, ‘what is the growth scenario that is now priced into the market? How much acceleration is in the price and how does that compare to the acceleration that is actually coming?’ The best indicator for the equity market is called the PMI. It’s a measure of business confidence. It has fallen from a peak of 53 to 44. The market is priced for it to go to 54, but given the large amount of spare capacity you’ve got in the economy, that likely will be reactivated next year, we think the PMI will go to 60. That means a lot of good news is in the price, but there’s more to come. We have just turned neutral on the market after a 40% rally, simply because the market has overshot. It has looked through the near-term growth weakness. We see no further upside until around March. But if we’re right that by the middle of the year you will have a very strong growth environment, there’s another 10% upside, also to 440 on the STOXX 600. We are saying, that this upside is unlikely to materialize in the near-term, but if there’s any pullback, or if we finally get to the point that the market doesn’t move very much, then from the end of the first quarter onwards, we’ve got another 10% upside, before the cycle peaks by the middle of the year.
Dan Barnes That’s very interesting. What are the implications of that for individual sectors?
Seabstian Raedler Well, there you’ve got pretty much a bifurcation, especially among the cyclical sectors. On the one hand, you’ve got the ones where a lot of the good news is already in the price. Autos up 40%, capital goods up more than 20%. So, we were overweight early in the year, we’ve just neutralized that. And what we’re telling clients now is focus on the sectors that have very little of the good news priced in, but have the same macro sensitivity. That’s banks, insurance, energy, and that’s airlines, which until a month ago, nobody wanted to touch. They are only just participating in the recovery rally. And from our perspective, that’s where now the value lies.
Dan Barnes What are the biggest macro risks for the equity market going into 2021?
Seabstian Raedler We would say the biggest macro risk is a spike in bond yields, because the bond market has priced very little of the macro recovery. And we have seen in November how quickly these trades that have them, react and how quickly they can reprice the outlook. And so remember the taper tantrum of 2013? Remember the Bund tantrum of 2015? The biggest risk for 2021, we believe, is not on the growth from, but rather the discount rate suddenly rising sharply and you having multiples being compressed by a sharp spike in discount rates.
Dan Barnes That’s fantastic and that lets me turn now to Barnaby. In the fixed income space, just at the moment we’ve seen a lot of bonds issued, but are issuance volumes where you might expect for this time of year?
Barnaby Martin Well, December is typically a very quiet month, and we’re a week into December and it looks like we’ve already had over 10 billion of issuance. So I think this will prove to be a much higher than normal December. But I think for the whole year, I mean, look, it’s just been a phenomenal experience of companies being able to raise debt amid an enormous crisis. And that, for me, will be the legacy of the shock. Investment grade issuance this year should end around 600 billion, it’s an enormous number for European credit and it really reflects the depth of the market that we’ve seen. What drove us here, what got us here, it was the policy supernova, really, that we saw; the abundant intervention by the ECB, the pledging of more aggressive forms of quantitative easing. It just set the groundwork for liquidity to be raised by those who needed it the most.
Dan Barnes How is capital being used by the firms who are raising all this debt?
Barnaby Martin What happened in March and April was that the crisis hit for the first time ever. Economies were shut down en masse, and for companies, there wasreally only one option, which was to raise oodles of liquidity just to show that you were able to weather this storm. We’ve been making the argument that corporates went too far. I mean, a simple metric to look at is cash-divided-by-EBITDA; so how much cash does a company hold as a measure of its previous earnings. And looking at that over time, what you can see is in the aftermath of successive crises, companies in Europe have tended to generally increase their cash buffers. We know during Lehman time, part of the problem was that corporates went into that crisis without very much in the way of cash buffer, so in the aftermath of that crisis, they started to run with high levels of cash-to-earnings. The sovereign crisis hit in 11′, 12′, and you saw the same kind of response. After this crisis, most companies in Europe are investment grade companies who are sitting on cash in excess of a whole year’s worth of earnings, which I just think is too big. I mean, I don’t think your classic company needs that much of a cash buffer. So, next year will be very different. I do believe that you will see no financials not issue as much, but I do think you will see a record year for tenders of debt at the front end of the curve, because the one way to use that excess cash efficiently, is now to buy back your bonds.
Dan Barnes Have the covenants being proffered been getting tougher, because you have had some concerns around the covenants?
Barnaby Martin Well, for investment grade, it’s never really a mark of covenants, it’s more a question of the quality of issuance that’s coming and we’re seeing more triple B’s, we’re seeing more subordinated debt. A few months ago was a very big month for corporate hybrid issuance, which is subordinated, corporate debt. So in that respect, the riskiness of issuance that’s coming is growing, but that’s something that the market is comfortable embracing. In high yield and in the leveraged, loan market, there’s been an attempt to push back on very loose covenants. But again, we’re in such a euphoric period for asset markets, that cut loose tends to win out. I mean, it’s only in a ‘bear market’ where the stringency of your covenants tends to pick up.
Dan Barnes And how have the rates markets been impacting credit?
Barnaby Martin Well, it’s all about financial repression. There’s 64 trillion of debt out there in global bond markets, and only 28% of it yields above 1% today. I mean, it’s a shocking number and it’s a terrible challenge for investors to find yields next year. So that’s really your greatest tailwinds for corporate bond investing in high yielding parts of the market; so the high yield, 81, corporate hybrids, etc.. So this environment are very depressed yields, this environment of central banks cutting rates below zero has driven an enormous thirst for yield for corporate bonds in the last four to five years. And it’s eventually starting to benefit markets like high yield, because it’s really the only place you can go as an investor to get yields in excess of 1%.
Dan Barnes That’s great. Gentlemen, thank you very much.
Seabstian Raedler Thanks.
Barnaby Martin Thank you.