Waiting for the ‘fat pitch’
Caution on euro credit
A great advantage in managing money is having the ability to wait: avoiding a situation where you have to invest. This means you can pass on an investment idea simply because it doesn’t look interesting enough and wait for truly great opportunities. American baseball fans call this “waiting for the fat pitch”.
In multi-asset investing, our universe is broad and global. All investment opportunities constantly have to compete with other asset classes or regions, and there is no absolute need to invest in any specific investment type. This allows us to have patience and wait for that pitch straight over the middle of the plate, which hopefully enables us to hit it out of the park more easily.
Realising that baseball might be quite far away from the day to day life of my UK readers, I have asked my British colleagues to come up with a proper cricket analogy of a 'fat pitch' and they ensure me that 'half volley' works best. For a Dutchy, it sounds like a tennis stroke but what do I know about cricket?
For example, we have no issue passing on opportunities in fixed income when we see better ones in currency, equities or even commodities. Today, we believe investors need to be careful about the risk of striking out in European investment grade credit. Instead they should wait for a “fat pitch”, a proper buying opportunity, that may be coming later.
This belief is based on the following arguments:
- Investment grade credit spreads are now very tight (back to within a few basis points of the 2014 lows).
- Longer term, tight credit spreads are likely to trigger some kind of supply response (e.g. the kind of corporate re-leveraging seen in the US)
- Shorter term, the tapering of corporate bond purchases by the ECB has already started, and is set to accelerate in 2018
Investors are increasingly complacent about European economic and political risks. The consensus probability of recession in the next twelve months has dropped to a barely credible 7%: the lowest for at least five years.
Driven by ECB bond-buying, European investment grade credit spreads are trading inside the 10th percentile of the last decade. Similar spread compression is apparent in other parts of the credit market (e.g. global high yield), but has been less powerful elsewhere (e.g. emerging market and peripheral sovereign debt).
In this light, we have gone from having a cautious outlook on European investment grade credit to having a more clearly negative view on a medium-term basis. There is a risk that we are too early in this call given few concerns about an imminent pick-up in European corporate defaults. In similar conditions, credit spreads stayed at these levels or lower for four consecutive years from 2003 to 2007. However, it is hard to see much further spread tightening given today’s heady valuations.
We prefer to take risk elsewhere and wait for the fat pitch tomorrow, rather than swinging and missing today. Though no asset classes look really cheap to us we still see reasonable risk reward in some parts of fixed income, for instance hard currency emerging market debt.