A resolution to the current supply/demand imbalance plaguing Asia’s international bond markets does not appear to be any closer. October was yet another month of low primary market subscriptions and poor secondary market performance.
"In some ways it's a question of who’ll blink first,” said Clifford Lee, head of Asian fixed income at DBS in Singapore. “Will it be issuers, which need to access the market, or investors, which are sitting on large cash piles they need to re-invest before year-end?”
Yet even when issuers accept that they have to offer bargain basement pricing, few investors seem to feel compelled to place orders, particularly when it comes to lower rated Chinese borrowers.
At its most extreme, unrated China Properties set a new pricing low in mid-October when it offered a 15% coupon for a three-year deal.
Earlier this week, Evergrande managed to top this and swing a wrecking ball through the high yield market for the second year in a row after it overwhelmed the market with $1.8 billion of new paper at a new issue premium of between 110bp and 180bp.
Double digit coupons have become the norm. Jake Gearthart, co-head of Deutsche Bank's financing and solutions group for Asia Pacific, is not sure that the situation will change anytime soon.
"There's also been some debate about how liquid investors' cash holdings actually are since large chunks are invested in short-term bills,” he commented. “They’ll need to be actively persuaded to cash out of them by a combination of compelling credits and pricing."
Manu George, director of fixed income at Schroders in Singapore, believes that investors can afford to be picky and are under no compulsion to put money back to work.
"Certain firms may feel the need to become more active because they’re sitting on losses," he stated. "But we can be extremely selective, particularly since safe haven assets like US Treasuries are now yielding over 3%."
George says that beta is a very dangerous game to play right now.
"Put your money in the wrong credit, or the wrong country and it’s very easy to get flattened," he asserted. "The only high yield names we're investing in are the ones we have a very high conviction about."
As a result, Schroders' multi sector strategy has more than a 45% weighting in local and hard currency government bonds, including China's CGBs and Singapore's SGSs. George said the ratio could easily go above 50%.
High yield corporates now account for just over 12% of the portfolio, with a further 7% invested in cash or cash equivalents.
Adam McCabe, head of Asian fixed income at Aberdeen Standard Investments, also told FinanceAsia that he does not feel the need to chase each and every deal. He has a more optimistic outlook than many of his peers across both the buy-side and sell-side, however.
“We’d rather be invested than not, and we see value opening up in some of China’s higher quality property names given there’s no fundamental reason why they cannot refinance,” he commented.
GOOD NEWS/BAD NEWS
McCabe says that one of Aberdeen’s chief areas of focus has been how much bad news has already been priced into the market. Its conclusion is - the worst-case scenario.
“It’s very apparent that the market has yet to overcome its concerns about the impact of trade tensions and China’s de-leveraging campaign on Asian credit,” he said.
But McCabe believes that sentiment could turn quite quickly if there are any positive headlines about trade talks between China and the US, or less hawkish comments from the Federal Reserve.
“While there’s every reason to be cautious given that global liquidity is tightening, we do think we could start to see some value open up across domestic bond markets, particularly if inflation stays in check as growth moderates,” he remarked.
McCabe reckons that improving sentiment will initially manifest itself in currencies, followed by non-Chinese high yield spreads.
Deutsche’s Gearhart put forward a similar argument. “The world economy has clearly passed peak growth,” he said. “But growth is still pretty good and so long as inflation stays in check, then bond market conditions could become a lot more benign.”
On the flip side, worsening credit conditions could start to put a lot more pressure on lower rated investment grade credits. Many believe that this could be the next shoe to drop.
In a report published last week, Moody’s highlighted the growing strains at the lowest reaches of the Asian credit universe. Its Asian Liquidity Stress Indicator, which measures trends in speculative grade liquidity, is not far off the all-time high it hit in April 2016.
“So far it has been Asian high yield which has been plagued by exogenous shocks rather than fundamental credit concerns,” Gearhart continued. “But it could yet turn out to be the canary in the coal mine for the overall market.”
Gearhart argues that if credit conditions weaken further “then there has to be some kind of drag on investment grade credits too.”
The data underlines the divergence in performance between the two credit classes. As of the week ended October 26, for example, the Bloomberg Asian Investment Grade Index had widened out 28bp relative to Treasuries year-to-date, compared to 149bp for the Bloomberg Asian High Yield Index.
McCabe points out that a lot of lower-rated investment grade paper is in the hands of buy-and-hold accounts such as insurance companies and high net worth investors.
“A lot of their portfolios have been pushed right to the edge of the investment grade spectrum,” he explained. “Those buy-and-hold investors may start selling if low investment grade credits start getting downgraded to high yield, or markets get nervous that they’re heading in that direction.”
Schroders' George also believes it is inevitable that Asian currencies will be tested again. “Markets cannot get away from the fact that the Fed can continue raising rates past the neutral rate suggested by the dot plot until such a time that it constrains economic activity,” he commented.
He argues that while Asian valuations have corrected, upside may remain challenging against this rising rates background, although he adds that they should stabilize if there are no more nasty shocks.
DBS’s Lee concurs. “The market is still trying to heal itself after the nasty jolt at the beginning of the year, but it’s still very vulnerable to geopolitical tensions,” he concluded.
Gearhart adds that while conditions remain fragile, there is a "decent pipeline" ahead.
"October hasn't been an overwhelming month, but there are a fair number of sovereign and state-owned enterprises lining up, to which investors normally respond well," he commented. "If market conditions weaken in November, however, or supply gets too heavy, then we could well see more of the pipeline seep into December than we have in recent years.