Summer is drawing to a close amid a growing consensus that the global recession has also reached its denouement. Bullish investors are having little trouble finding positive indicators, both in the economic and corporate sphere. Yesterday, US unemployment claims figures for last week came in at 550,000, down from the previous week and lower than expected. Better than expected consumer sentiment figures released today added to the upbeat mood.
And the good news was not just coming from the US. Today, China released a slew of data showing that its domestic economy is heading back towards trend growth rates. Industrial production was up by 12.3% in August, a 12-month high and an improvement from the 10.8% posted in July. Fixed asset investment was up by 33% compared to the same month last year, a slight improvement from July. Bank lending and the money supply continued to rise sharply, though some might view this as a negative given concerns about frothy asset valuations. Markit’s Global PMI moved into expansion territory for the first time in 15 months, signalling an end to the global recession.
A resurgent corporate sector gave additional reasons for optimism. M&A activity, moribund during the last two years, was back on the agenda. Kraft Foods launched a takeover offer for British confectionery firm Cadbury. The approach was rebuffed, with Cadbury’s board and shareholders confident they can extract a higher price, whether from Kraft or another potential bidder such as Nestle. Vivendi announced the acquisition of a majority stake in GVT, a Brazilian telecoms operator. Also in telecoms, Deutsche Telekom and France Telekom announced they would merge their UK mobile operations. It should be noted that while M&A activity is a bull market signal and often positive for equity markets, the impact on credit markets is more ambiguous. Spreads in Kraft and Vivendi widened on expectations of balance sheet deterioration.
The credit and equity markets appear convinced by the strong recovery scenario. Spreads have tightened sharply this week after a lacklustre August, and stock indices in Europe and the US have broken through key resistance levels. The rise in risk appetite can be see in the normalising credit curve. The trend towards curves normalising, i.e. becoming positive-shaped (10 year – 5 year), began some months ago and has continued in recent weeks. The chart above shows that the total number of positive-shaped curves has risen from early last month, when spreads were at tighter levels. Financials and telecoms credits make up a high proportion of the names. Telecom operators have steady cash flows and most have successfully extended their debt maturity profiles.
The US, lagging behind Europe in this respect, has seen a sharp increase in normal curves in recent weeks. The distribution across sectors is more even, though the relatively low number of financials is notable. Unlike their counterparts in Europe, most US banks still have inverse curves. Higher-quality names such JPM and Wells Fargo have seen some normalisation.
The capital markets have provided further evidence of bullish sentiment. European bond issuance has reached $2,000 billion so far this year, according to Dealogic. This is 38% higher than the whole of 2008 and is the fastest ever pace of issuance. The advantageous market conditions are prompting several firms to raise capital in both the equity and debt markets. Continental and Heidelberg Cement, two junk-rated German firms struggling with large debt burdens, are thought to be planning capital hikes in the coming months. The credit markets welcomed the prospect of balance sheet improvement, and investors will expect other high yield firms to follow suit.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.