The year is coming to an end and the results are worse than our initial bearish expectations. Spreads are much wider than a year ago and most credit indices are posting negative returns.
The good news is that yields are much higher now than 12 months ago, and we wisely kept cash available for investments. In our view the level of spreads now compensate for most if not all the uncertainties ahead.
Furthermore, we expect spreads overall to end 2019 at very similar levels, meaning that excess returns should be positive by the end of next year. So 2018 was very difficult, but 2019 should be much better, even if the journey likely will remain volatile.
In the very short term, we may well see a shortlived rally into year end and January as investors put cash to work. However, we expect macro and political risks to take their toll on the market, and push spreads wider. As such, we expect the inflection point to come around mid-May.
At the moment the have 26.49% exposure to corporate bonds and a negative exposure to Italian BTP. We expect the BTP rally to be short lived although we expect the budget law to pass the vote in parliament. The risks are more on the implementation side afterwards.
We maintain a substantial reserve in cash (about 48% between Eur, GBP and USD) and we will focus where the geopolitical risks are less pregnant and growth is more certain. All eyes are on the relationship between Us and China. A change in these variables the have a substantial impact on the bond market volatility.
We monitor carefully the M&A world as integration in certain sectors seems at the gates. Telecoms and Automotive being the best candidates for some reshuffling in the shareholding structures.
The cash market is closing the year much wider than where it started despite the tightening of the past week. Still the iBoxx Corporates index is ending around 75bp wider than a year ago and yielding 1.62%. The EUR HY market is closing around 230bp wider with a yield of 4.95%.
In both cases, the carry earned through the year was not enough to offset the rise in yields, pushing total returns to -1.30% and -3.51%, respectively.