High yield credit: sector performance in 2021

Markets summary

The coronavirus pandemic has, since first detected in the Capital of Hubei Province - Wuhan, dominated news headlines. It caught the world by surprise, altering life patterns and the dictating the economy path forward.

A significant rise in infections drove governments, at the expense of the respective economic situation, to intervene. Safeguarding the wellbeing of its people became, in most instances, the foremost objective. Nonetheless, millions succumbed.

Governments, through mitigations measures, such as the imposition of movement restrictions and vaccination campaigns, following a discovery towards the end of 2020, proved crucial. The scenario drastically improved, with a notable decline in infections, hospitalisations, and ultimately deaths. Here, a distinction must be made, between the developed market world and the more emergent countries, which initially took longer to feel the impact, yet suffered greatly when the pandemic forcefully hit. A lack of vaccine availability and in part reluctance to be inoculated worsened an already tensed situation.

From an economic viewpoint, central bankers and governments, through monetary and fiscal aid, cushioned the impact. Monetary intervention allowed corporates to tap the primary market at low favourable rates, while fiscal intervention allowed corporates to maintain their cash buffers and ultimately survive. The latter at the expense of increased debt levels, and thus rise in the ‘Debt-to-GDP’ metric.

Mitigation measures imposed combined with vaccination programmes, allowed economies to reopen. The reopening argument, albeit at times uneasy due to a new wave of infections and discovery of mutation variants, all-in-all, paid dividends, proving to be the winning trade in 2021. That said, sectors sensitive to economic reopening and a recovery, ultimately resulting in higher demand, have generally saw corporate credit spreads tightening. Sector specific and geographical issues have at times, however, dictated overall performance.

Sectors such as basic industry, retail, and transportation were amongst the best performing, witnessing a tightening in credit spreads. Real estate, particularly in Emerging Market high yield corporate credit, remained conditioned by policy action in China and Evergrande group’s default.

Basic Industry: Increased demand stemming from infrastructural investment by governments to instil economic growth, and supply constraints – generally due to coronavirus-inflicted movement restrictions, have over the past year led to notable price increases for base metals. Industrial metals also continued to be supported by the long-term goals of the green-energy transition. A metal which performed strongly and that falls within the latter category is Lithium.

Consequent to robust demand stemming from the automotive industry - driven by government incentives to reduce CO2 emissions, and tight supplies, Lithium Carbonate, a critical ingredient in lithium-ion batteries for electric cars registered gains of over 400 per cent – the best performing industrial metal on a year-to-date basis.

Retail: The outlook for the retail sector, amid a sizeable vaccine uptake and thus increased immunisation against the coronavirus and other emerging variants, had seemingly improved. The

reopening of economies, indeed had led to a recovery, following a dismal 2020. However, the Covid-19 saga is far from over. A rise in infections, possibly due to a seasonal effect which may probably contribute to a bigger outbreak, is once again being witnessed.

In recent weeks, Europe and the U.S. experienced a surge in coronavirus infections, to levels not seen in months. Inevitably the retail sector, a contact intensive industry felt the pinch. Sentiment on the sector dampened, with yields adjusting to a “new” reality. That said, the sector still remains positive on a year-to-date basis. While the industry may once more be impacted, following the steady rise in infections, a shift towards e-commerce may mitigate such impact. Once more, we may envisage a shift in demand towards goods from services, previously thriving as mitigation measures eased. Increased immunisation through vaccinations, particularly through a third dose, shall undoubtedly help to mitigate the impact on the healthcare system, this possibly also dictating the ensuing course of action taken by governments to mitigate the spread.

Transportation: The outlook for the transportation sector, previously conditioned by coronavirus-inflicted movement restrictions and then aided by the normalisation proposition, improved from 2020. Surely instilling confidence in the sector, specifically in the shipping segment, was a surge in demand.

The health crisis and ensuing restrictions on movement, 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 Q2 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, and a growing container shortage, worsened an already tensed situation.

Real estate: The dollar-denominated Chinese credit market, for quite some time posing as an attractive opportunity to investors in search for a higher yield, have over the past months, consequent to policy changes, built a narrative that a wide swathe of Chinese assets are under threat.

Sudden policy changes, better known as the ‘three red lines’, introduced by the CCP – the founding and sole governing political party of the People's Republic of China (PRC) and led by Xi Jinping, amongst others, include restrictions in financing on the highly-leveraged real estate segment. The set of strict financing rules include; Debt-to-Asset ratio below 70 per cent, Net debt-to-equity ratio below 100 per cent, and Cash-to-short-term debt ratio of more than 1x.

Heightening pressure on the Chinese credit market was a cash crunch at China’s Evergrande Group – one of the largest Chinese property developers, which stoked contagion fears in the real estate sector. Sentiment among investors further dampened as other real estate developers started to face liquidity issues. Modern Land (China), Kaisa, and Sinic were amongst those developers facing unprecedented liquidity pressure.

Consequent to the negative sentiment, which also dragged other issuers along despite not posing any specific risk, EM high yield names in the real estate segment witnessed a substantial widening in credit spreads.


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.

For more information visit https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.