EPSTEIN
page 9 / 469 . OCR, unverified
outperform HY, just like both of them did in 2015. We are not viewing 2.3 hikes
by the Fed as being problematic to credit. In our opinion, their ability to hike
multiple times would be proof that credit tightening concerns were overblown.
Also critical to our positive outlook on IG is the continued demand for 'safe
yield' from overseas investors, particularly those in Asia. Non-U.S. investors
absorbed roughly one-third of the net supply of U.S. issuer bonds in 2015 in a
great rotation to developed-market debt markets, in flows that appeared to
favor financial bonds, single-A corporates and 5-year and 30-year paper. The
laggard, 10-year BBBs. look cheap on a relative basis and we like owning these
bonds outright or through 2s10s flatteners.
Deutsche Sank AG/London
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December 2015
World Outlook 2016: Managing with less liquidity
The energy and materials sectors trade historically cheap to trailing
fundamentals, although their prospects are tied heavily to the willingness of
management teams to pare back bloated capital spending budgets that now
run at double the rate of EBITDA. We recommend avoiding sectors exposed to
the energy sector's coming capital expenditure declines, such as capital goods.
Trends in non-financial issuer quality outside the energy sector are also
worrisome, leading us to revise our view on the relative performance of senior
US bank paper, which we think can now trade to spread parity with quality-
and duration-matched non-financials.
Oleg Melentyev, (1)212 250 6779
Daniel Sorid, 11)212 250 1407
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December 2015
World Outlook 2016: Managing with less liquidity
European Credit Strategy: To follow the US or march to its
own beat?
Credit markets do have a late cycle feel about them but it will likely make a big
difference to performance over the next 12 months if this cycle ends in 2016 or
extends until at least 2017.
Fundamentals - US deteriorating. Eutope steadier but past peak
As Oleg Melentyev has alluded to in his US section, US credit quality has
deteriorated. However Europe credit quality remains much more stable.
Figure I: US 10 total and net leverage
2.5
moo Total Leverage
mum Net Leverage
2.1
1.9
1.7
?11
0.1.97
nn
1111
111 11111
2006 2007 2008 2009 2010 2011 2012 2013 2014 2016
Net (floored at $01—ex-Energy/Metals
Souc• bueictidt Bat Reawirch
I igurti 2. US HY total and net leverage
Total Leverage
SS
Net Leverage
ox Energy/Mining
6.5
6.0
5.5
5.0
3.0
4.5
4.0
2.5
3.5
2006 2007 2008 2009 2011 2012 2013 2014
San, Oetatli• BM Parrett
In Europe there are sign that earnings have been drifting lower but debt
accumulation has been nowhere near as aggressive as in the US market thus
helping the ratios. European credit has far less exposure to the Energy and
Materials sectors, which has helped create some of the divergence.
Figure 3: Euro IG (left) and HY (right) credit fundamentals
I0
2002
2001
20.06
2008
2010
2012
2014
2000
Sown Deuath• ant Reno% Blerembro Anent* LP
4.5
4.0
3.5
3.0
2.5
2.0
2007
2009
2011
≥013
2005
Net Debt/E8ITDA
—EBITDA/Interest
Another reason for diverging fundamentals has been corporate activity. US
M&A has risen much more sharply than in Europe. For share buybacks the
divergence between the US and Europe is even more extreme. Europe has
actually seen less in buybacks in 2015 than what was seen over the past
decade whereas the US volume remains historically high even if not quite
reaching peak levels.
Deutsche Bank AG/London
2015
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December 2015
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!Figure 4: US and European M&A activity (left) and share buybacks (right)
2.500
2,000
1.500
1,000
500
• US Acquirer •WE Acquirer
700
• US (S&P 500)
• Europe (Stoxx 600)
600
500
400
300
200
100
8
No 8 8
00000000
00000
NNNNNNNNNNNNN
Am far 2 0 lS wroth* end a Nombre
Sane DeunoM Sw "march
I
6 6 6 61 6 c&)— c&
"') c&'"'
eeeeeeeeemeee
0000000
00000000
Overall these charts show that Europe is some way behind the US in terms of a
deteriorating credit cycle. As such even if US credit widens further, it's
possible that European credit can continue to outperform. We would be mildly