JPMAM’s Michalitsianos: The (new) issue with European investment grade

by | Jan 15, 2024

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Andreas Michalitsianos – Global Investment Grade Corporate Credit Portfolio Manager at J.P. Morgan Asset Management, explains why European investment grade credit looks attractive vs US corporates.

“Two weeks into the new year and the European primary market is off to a flying start, with record issuance days in the sovereign space, and investment grade (IG) issuance exceeding expectations. In my view, this presents an attractive opportunity for investors.”

Fundamental factors

 
 

Global IG company fundamentals are holding up as the macroeconomic environment shifts to lower inflation and the potential for interest rate cuts. In Europe, concerns that the corporate environment is getting tougher are not materialising in the hard data and we estimate that revenues will stabilise through the middle of 2024. Balance sheets generally remain robust with leverage at the low end of historical ranges, and management teams have generally been disciplined in capital allocation, with a continued emphasis on strong liquidity and ratings stability.

For European banks, deposit trends show greater stickiness than in the US, and improved pre-provision operating profit means comfortable headroom to absorb a potential higher cost of risk (charge off) environment.

Quantitative valuations

 

Corporate credit spreads tightened into the end of 2023 after the dovish pivots signalled by central banks in November. However, with recent primary issuance, European corporates are now 6 basis points (bps) wider year to date at 144bps, compared to the US corporate market (where issuance has been more in line with expectations), trading only 1bp wider at 100bps. In absolute terms, we think European spreads look fairly attractive at these levels. Recent price activity supports our view that European investment grade credit looks relatively attractive versus US. The European corporate market is shorter duration (4.4 years vs 7.1 years in US), but still offers attractive all-in yields at 3.75% vs US at 5.21% yield to worst – or 3.73% when swapping to euros – (all data as at 9 Jan 2024, source Barclays).

Technical factors

From a demand perspective, technicals are supportive for European IG credit. Fund flow data into European credit has been positive week-on-week from November, and flow data tends to correlate with positive returns. This suggests given the recent total return performance for credit markets that retail inflows will persist for the near term. Initial consensus supply expectations heading into January for European IG were around €65bn-70bn, though we have already seen €50bn print in the first seven trading days of the year. Supply has predominantly been in the financials sector and has been well absorbed by market participants, with strong demand and several deals trading 15bps tighter versus new issue pricing. We expect a slowdown in supply into the second half of January given the front-loading of recent deals and as companies enter the reporting season, which is further supportive as a near-term technical.

 

What it all means

We think investors should look for opportunities to add risk in European credit. While there are structural reasons to support a differential between the European and US corporate markets (driven by their different stages in the growth cycle, the greater liquidity and size of US market, and technical factors such as relative swap spread differentials), we believe there is certainly scope for this differential to compress.

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