Credit Assets Expected To Preform Well Into 2013

Risk assets have performed very well over the past year. Stock markets have rallied, and many markets have reached new highs this week. Spread compression has also continued, taking both peripheral and credit spreads to new lows.

Looking into 2014, our view is that credit assets will continue to perform well, but we do not expect them to deliver the same high returns as 2013. This is hardly a controversial view. It is actually pretty close to consensus, which we do not really like. However, sometimes consensus turns out to be right. When strong trends are established, it becomes consensus after a while. Why kill a winning strategy? Also, sometimes it becomes self-fulfilling. Of course, one day it stops and then everyone is looking for the door at the same time – as happened in 2008. It could happen again a few years down the road but, for now, we see the continuation of the trends from 2013 in 2014, albeit at a slower pace.

The arguments for continued performance are still very much in place, we believe. Even though risk premiums have come down a lot, we expect an environment in the coming years where the hunt for yield continues and risk assets become expensive – as we saw with credit in the period 2003-07. This time the arguments might be even stronger.

First, rates will be even lower this time – and for even longer. In the period 2003-07, the Fed was talking about raising rates at a ‘measured pace’. It led to 17 consecutive hikes of 25bp in the period July 2004 to June 2006 of a cumulative 4.25 percentage points (from 1.00% to 5.25%). Now the Fed is signalling rates will stay unchanged until the middle of 2015 and the pace of hiking the Fed projects is only half the pace of what it saw as a measured pace in the 2000s. The ECB has just cut rates and is likely to ease further early next year and put more liquidity into a global system that is already flooded with liquidity by the Fed and Bank of Japan. Inflation pressures are much lower this time (low wage increases and falling commodity prices) and output gaps higher, which means monetary policy is likely to be even more accommodative in this recovery than in the one in the 2000s.

Second, we expect the global recovery to continue and strengthen in the coming years – with a much lower starting point than in the 2000s. The major headwinds following the financial crisis (euro debt crisis and fiscal austerity) are easing fast and should continue to do so in coming years. In both the US and the euro area, fiscal policy will be close to neutral next year after being a significant drag for some time. We believe that recovery will become broader based, pulling on more engines with stronger growth in the US, Europe and emerging markets.

As an investor, this environment can be quite difficult because it makes it hard to find good risk/reward trades. It may be the environment where the trend followers will perform and fundamental players find it difficult as assets very easily get to look expensive. Some assets already do – in the high yield space for example.

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