Sectors benefitting from a resumption to normality, outperform | Calamatta Cuschieri

Markets summary

Since first detected in January 2020, the coronavirus pandemic and ensuing global response have dictated economic activity and credit markets way forward.

Initially, the economic landscape, following the imposition of movement restrictions, deteriorated. Credit markets, witnessed credit spreads reaching significant highs of over 1000bps. Then, a concerted effort by both Central banks and governments led to what we have been witnessing in 2021 – a robust economic recovery and upward trajectory in financial markets.

The concerted effort proved crucial. Monetary intervention by respective central banks allowed corporates to tap the primary market at low favourable rates while fiscal intervention by governments allowed businesses to maintain their cash buffers and ultimately survive. The improvement in macroeconomic conditions along with vaccination programmes being well underway, particularly in the developed market world, triggered a risk-on mode. The re-opening of economies, further bode well pushing credit markets higher.

In-line with improved macroeconomic conditions and credit metrics (owing to deleveraging assisted by improved earnings and refinancing at favourable rates), corporate credit spreads, have in 2021 continued to tighten. Sectors benefitting from a resumption to normality and thus economic recovery, outperformed.   

Leisure and Retail: The vaccination rollout in many developed countries being well underway allowed for the unlocking of economies and a gradual return to normality. Sentiment improved as restrictive measures were eased. Inevitably, contact intensive sectors reliant on mobility such as leisure and retail, benefitted.

Albeit optimism was partly dented following a recent spike in coronavirus cases, owing to the significantly more contagious Delta variant, high yield issuers (more speculative bonds with a credit rating below the investment grade tranche) within the leisure and retail segment, continued to advance. U.S., European, and Emerging Market (EM) high yield names within the leisure and retail sector witnessed substantial credit spread tightening.

European high yield issuers within the leisure segment witnessed spread tightening of 166bps since the start of the year. Meanwhile, EM high yield issuers within the retail sector saw spread tightening of 422bps.

The outlook for the said sectors, shall improve, should the recent pace of vaccinations be maintained. To further increase immunisation, particularly against the Delta variant, some countries also announced booster programmes to deliver third doses to their population. It is worth highlighting that the currently available one or two-dose vaccinations, may prevent deaths but not prevent the Delta variant’s transmission.

Services: While the manufacturing sector showed remarkable resilience during a period characterised by coronavirus-induced movement restrictions, services – reliant on mobility and thus direct contact, suffered.

Indeed, increased immunisation led to a resumption in activity. Sentiment, consequently, improved. Services Purchasing Managers’ Index (PMI) – an index of the prevailing direction of economic trends, portrayed such scenario.

A long-awaited pick-up in services in Europe and the U.S. transpired. Following a steep pace of expansion, the growth momentum within the services sector has seemingly hit a stumble block. Eurozone Services PMI in August dropped to 59.0, from July’s 59.8. Also, the U.S. Services PMI reading pointed lower to 55.1, little changed from a preliminary estimate of 55.2. A reading above 50 marks an expansion.

U.S., European, and EM high yield names within the services sector have on a year-to-date basis witnessed spread tightening. EM high yield issuers outperformed, witnessing spread tightening of 299bps.

Transportation: The outlook for the transportation sector, previously conditioned by coronavirus-inflicted movement restrictions and now aided by the normalisation proposition, improved. Certainly instilling confidence in the sector, specifically in the shipping segment, was a surge in demand.

An industry that initially seemed to be sailing in treacherous waters have navigated 2020 and beyond, well. This, notwithstanding the challenges faced, notably; the introduction of IMO2020 – an environmental regulation set to reduce emissions released from vessels, and disruptions stemming from the unprecedented coronavirus outbreak.

The health crisis and ensuing restrictions on movement to mitigate the spread, resulted in a shift of retail consumption in favour of goods rather than services. This, notably supported by the development of e-commerce. Consequent to this shift, the demand for transport and logistic services recovered quickly from the trough levels witnessed in 2Q 2020. Shipping liners have been operating at full or quasi-full capacity ever since.

Since the end of last year, the level of demand combined with the disruptions relating to the pandemic, such as staff shortages, have created a severe congestion in global supply chains. In container shipping, this translated into slower asset rotations and severe capacity shortages. The Suez incident towards the end of March, port closures in May, and a growing container shortage, worsened an already tensed situation.

Expectations for liners 2021 full year financial results are highly anticipated, with optimism. Seasonal trends, tight market conditions, recovering, economies, stimulus measures, limited available containers, and port congestion shall keep rates above historical levels. This, undoubtedly, positively driving strong earnings.

U.S. high yield names within the transportation sector recorded credit spread tightening of 275bps on a year-to-date basis. 

Energy: Crude oil - strongly depressed in the first half of 2020, consequent to a fall in demand due to the health crisis and breaking up of the OPEC+ agreement, registered substantial gains in the second half of the year. The re-opening of economies following a decline in coronavirus cases and steady developments on a coronavirus vaccine boosted hopes for a sustained recovery in economic activity and energy demand.

The single most important commodity in the world begun 2021, nearly how it ended – on a positive trajectory.

Crude oil – a liquid fuel source extracted through drilling and used for transportation, heating and electricity generation, varied petroleum products, and plastics, surged 49 per cent on a year-to-date basis.

The upward move in crude prices, correlated to the improved macroeconomic outlook, in addition to the recent moves made by OPEC+ in regards to supply, led to credit spread tightening within the sector.

U.S., European, and EM high yield names within the energy sector witnessed spread tightening. U.S. high yield issuers outperformed with credit spread tightening of 181bps.


Disclaimer: This article was written by Christopher Cutajar, Credit Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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