How wide can Asian credit spreads get?
Short-term volatility notwithstanding, we believe that valuations of Asian high yield bonds have reached attractive levels from a historical perspective, especially for investors with a medium-to-long-term horizon. Since end September 2005, investors who have entered the market at spread levels of above 800 bps, would have enjoyed an average annualised total return of 16% on a rolling 3-year basis6.
Furthermore, we believe that there are important differences which sets the current market situation apart from the GFC. These differences suggest that the spreads of Asian high yield bonds are unlikely to revisit the levels last seen at the peak of the GFC.
The change in investor profile is one key factor. Before 2008, Asian investors accounted for less than 50% of Asian bond allocation. Today, allocation to Asian investors represents more than 70% of the new issuances. See Fig. 3. We believe that a large Asian investor base potentially reduces selling pressure from cross-over funds or speculative investors outside of Asia, who may be quicker to sell down non-benchmark investments in their portfolios. Asian investors’ familiarity to the region and to the bond issuers should also help to mitigate risks of indiscriminate selling at the first sign of market weakness.
On the macroeconomic front, while we acknowledge that there is still much uncertainty with regard to the length and severity of the Covid-19 outbreak, there are also notable differences from the GFC. The GFC was a sudden systemic shock that was triggered by a breakdown in the financial system which had spillover effects onto the real economy. Today, global banks are less leveraged and much better regulated. The current sharp slowdown in global economic activity, caused by the mandatory and self-enforced containment measures, would hurt corporate and household incomes. The amount of stress on corporates and households, as well as the shape of the recovery, would depend on how the virus situation unfolds.
We remain hopeful that the economic impact of the virus is only temporary and there could be a potential rebound once we see signs that the outbreak is being contained in major economies. Around the world, governments have rolled out unprecedented policy measures to combat the economic impact of the outbreak; these would help many companies ride through the short-term challenges. In the US, a USD2 tr Phase 3 fiscal package was recently announced; providing direct cash transfers to households, as well as rolling out a lending program and government guaranteed loans to companies. The Federal Reserve has also launched a raft of measures aimed at lowering borrowing costs and providing liquidity to the market. In Asia, policy rates have been cut in a hurry, some to record lows, while unprecedented fiscal measures have also been rolled out.
China’s experience in dealing with the virus also gives us hope that the setback to growth, while steep at its peak, could be transitory if the outbreak can be effectively contained. We are currently seeing economic activities gradually resume in China. Power consumption has increased and property sales as well as construction activities have resumed.
While it is debatable whether investor sentiment has bottomed, history shows that it is possible for Asian credits to lead the recovery ahead of the equity market, as was the case during the GFC. Fig. 4 shows that the Asian high yield credit market, led the equity market by a good 3 months. The S&P 500 bottomed in March 2009 while Asian high yield corporate bonds bottomed much earlier, in November 2008.