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Analysts caught flat-footed in 2018

Many anticipated a strong year for Asia's US dollar bond market but the trade war and Chinese defaults derailed the forecast, contributing to the worst sell-off in a decade

Hong Kong

AFTER a blockbuster 2017, the stars seemed aligned for another strong year for Asia's US dollar bond market in 2018. Then the trade war and a record spate of Chinese defaults intervened, contributing to the worst sell-off in a decade.

JPMorgan Chase & Co and Bank of America Corp were among those at the start of the year anticipating lower premiums for corporate debt, amid a solid global economic outlook and continued historically low interest rates. Sharper-than-expected hits from Federal Reserve tightening and China's deleveraging campaign, along with the blow to sentiment from trade tensions, sent spreads surging 109 basis points to the highest in about three years.

"Rising US rates, weakness in the RMB (yuan) versus the (US) dollar, EM (emerging markets) concerns spilling over and trade war tensions all contributed to this shift in investor sentiment" for Asian high-yield bonds, Goldman Sachs Group Inc strategists including Kenneth Ho wrote in their 2019 outlook. "We view the key reasons for the underperformance are tighter credit conditions in China and rising onshore defaults."

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Asia's investment grade bonds handed investors a 1.4 per cent loss since the start of the year. That left even Goldman's forecast of a zero per cent return looking too optimistic.

The asset class is just one of countless that are heading for a down year, with the broadest losses in more than a century by one measure. Some 89 per cent of assets have handed investor losses, Deutsche Bank AG calculated last month.

Some, including analysts at Australia & New Zealand Banking Group Ltd and Morgan Stanley, did anticipate a more challenging environment for Asian bonds in 2018.

Both those teams advised underweighting the securities of China property companies. Borrowing costs in US dollars for China's high-yield issuers, most of whom are property developers, almost doubled this year to 11 per cent, the highest in about four years, ICE BofAML indexes show.

Record local defaults in China, induced by a crackdown on shadow financing, sent overseas investors running for cover as well. A jump of more than 40 basis points in the benchmark 10-year US Treasury yield this year has also hurt returns.

Here is a look at what major banks had expected for Asian US dollar bonds in 2018, and how they actually performed.

JPMorgan forecast a 15 basis points overall credit spread tightening to 212 basis points in 2018, with 25 basis points of spread narrowing in high grade and 37 basis points of widening in high yield; expected a total return of 4 per cent.

What happened: Overall spreads widened 109 basis points this year to 282 basis points as at Tuesday, with 54 basis points of widening in high grade and 319 basis points widening in high yield; total return has been a negative 2.1 percent, according to ICE BofAML indexes. A JPMorgan strategist was not immediately available for comment.

UBS Group AG expected total return of 1.3 per cent for high grade and 5.1 per cent for high yield.

What happened: Asian investment- grade bonds handed investors a 1.4 per cent loss while junk is down 4.9 per cent. A UBS representative declined to comment.

BofAML preferred B rated securities to BB in Asia, liked China industrial credits and high-beta B property.

What happened: B rated Asian US dollar bonds saw a 5.7 per cent loss, while BB rated names lost 3.3 per cent. Chinese high-yield real estate credits were down 4.7 per cent, according to ICE BofAML indexes. The bank declined specific comment on its original 2018 call, while noting that revisions were made during 2018.

Goldman Sachs China property high yield was the bank's top pick, seen generating the highest total return in 2018.

What happened: The sector saw a loss of 4.7 per cent, worse than the negative 2.1 per cent return on overall Asian US dollar bonds, according to ICE BofAML indexes. According to a Goldman Sachs spokesman, the bank's analysts said in a report late last year that China property high-yield would be a top pick in 2018 due to "relative value opportunities" at that time.

Morgan Stanley preferred Asia investment grade over Asia high yield, and advised being underweight China high yield; saw spreads widening of 58 basis points as the base-case scenario.

What happened: Investment grade outperformed high yield, and spreads widened 109 basis points "As the saying goes, 'hindsight is 20/20.' 2018 clearly marks the end of the 10-year secular bull market in Asia credit," the bank's Asia credit strategist Kelvin Pang wrote in a Nov 25 note. "We don't think that we are at the bottom of the cycle yet."

ANZ had an underweight call on high yield and downgraded China property to underweight, seeing poor supply-demand dynamics.

What happened: High yield and China property securities did underperform the broader Asian US dollar bond market. BLOOMBERG