Finding Safe Harbor in Volatile Times
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Finding Safe Harbor in Volatile Times


Political turmoil in Europe is roiling the markets, but the latest All-Europe Fixed-Income Research Team leaders have answers on where to invest.

Britain’s exit from the European Union won’t take effect until 2019, but Brexit is already wreaking havoc with the region’s auto industry.

For one carmaker based in Western Europe, every 1 percent drop in the value of the British pound against the euro costs the company roughly €30 million ($31.8 million) in cash flow, says Barclays credit analyst Christophe Boulanger. A weakening pound has throttled back overall consumer demand for cars and sport utility vehicles in the United Kingdom by 5 percent. To push product out of the showroom, European automakers are offering cash incentives that slash listed prices by 20 percent, almost double the 10.5 percent of U.S. deals.

“European carmakers’ sales are actually doing well,” says Boulanger, Barclays’ chief credit analyst covering the manufacturing and general industrial sector. “The problem is that incentives are fairly high, which puts earnings quality at risk.”

Mark Wall, who heads the economics team at Deutsche Bank in London, says there’s no denying that Brexit portends a period of belt-tightening for an economy that’s 65 percent dependent on consumption and services. “People still have jobs and income, and they’re able to consume,” he says. “But households are exposed to rising import prices, and they’ll be experiencing a real-income shock this year as their discretionary income falls.”

Boulanger and Wall are among the top-ranked European credit analysts on Institutional Investor’s latest All-Europe Fixed-Income Research Team whose views clients seek in order to make sense of a welter of fast-moving events roiling the region’s economies, markets, and political institutions. (J.P. Morgan leads the pack for a seventh straight year, with 17 ranked analysts, followed by No. 2 Bank of America Merrill Lynch and No. 3 Deutsche Bank, which boasts nine first-team analysts. Barclays and Citi round out the top five.)

Fueled by nationalistic sentiment, not only is Brexit reshuffling the economic deck in Europe but — having foretold the improbable rise of Donald Trump in the U.S. — the plebiscite could be a harbinger of electoral things to come on the Continent. “Last year was the biggest step backward in the 60-year history of the European Union,” asserts Deutsche’s Wall.

Elsewhere in Europe, other campaigns have been dominated by jingoist candidates riding a wave of fear and resentment. In France, where elections will take place in two tranches commencing April 23, party leader Marine Le Pen of the National Front is gaining traction against the Republicans’ scandal-plagued François Fillon, the putative front-runner, with her message of returning to the franc and a Brexit-like referendum dubbed Frexit. In the Netherlands, elaborately coiffed Geert Wilders — a fiery opponent of Islam, immigration, and the EU who also wants out of the euro — is leading in the public opinion polls. But in a country known for its liberalism and tolerance, opposition parties are refusing to form a governing coalition with Wilders’ right-wing Party of Freedom.

The small country of 17 million people is deserving of far more attention than it is getting, insists Jacqueline Ineke, head of Morgan Stanley’s Zurich-based credit team covering banking and financial services.

“Holland uses the euro, and if it leaves, it breaks up the EU,” says Ineke. The result, she adds, would be catastrophic: “You can’t quantify the damage if the euro zone breaks apart.” Amid the turmoil Ineke’s team is recommending as safe havens the bonds of Swiss banks and Irish bank credits as the best “periphery play” in the EU.

James Reid, a top-rated high-yield debt strategist at Deutsche in London, notes that nearly forgotten in the commotion over Brexit has been the benefit of the quantitative easing program initiated by the European Central Bank last year, which purchased €65 billion in nonbank corporate bonds.

“In equities terms, it’s been the equivalent of the Federal Reserve injecting more than $65 billion into the S&P 500 index,” Reid says. He sees the Trump administration’s promised domestic infrastructure spending in the U.S., proposed corporate tax cuts, and expected regulatory rollbacks as net positives offsetting protectionist proposals like import taxes. Add to that “further ECB tapering and higher inflation,” he says, and “we think yields are going higher” in 2017.

His top sector overweight call this year is for credits of financials “both at the senior level and higher-beta exposure at the subordinated level. Rising nominal yields and steepening curves should support the trade.” Reid also sees investment-grade bonds outperforming high-yields this year, and he’s commending short-dated single-Bs for their “attractive yield pickup and lower default risk.”

Stephen Dulake, the London-based global head of credit research at J.P. Morgan, is also touting the credits of European banks over corporates as the ECB winds down its QE program. He thinks corporate bonds “were the last piece of the QE puzzle and could very well be the first to be withdrawn.”

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