Political risk in Europe and precautionary countermeasures have compressed credit spreads and threaten to drag back some of the current equity market bullishness, according to AMP Capital Investors head of credit markets Jeff Brunton.
Mr Brunton told InvestorDaily credit spreads over the past six months have compressed by around two thirds of what they would usually do through an entire economic cycle.
“Credit markets have had a really good start to the year,” he said.
“We’re still stuck in what we call the deleveraging, or the repair phase, of the credit cycle. The state of sovereign balance sheets, particularly in Europe, will come back to the forefront of market participants’ views at some point in 2013, we believe.”
There are nearer term risks in terms of the recent Italian election and the need for austerity measures in Europe to wind back government debt, which will have a negative feedback loop into the economy Mr Brunton said.
“We think that will just drag back the current bullishness we’re seeing in equities and other growth markets.”
Mr Brunton said the amount of new issuance in the global markets has broken through all records, despite it only being early in the year.
“The terms and conditions we see on the bonds coming to market today are not as good as they were in 2012, 2011 or 2010. We’ve stepped back a little but from buying, we’ve begun to let some bonds go into that bullishness that we see around us,” he said.
“We expect that spike in volatility at some point, and that’s the time that we’ll be looking for bonds.”
Mr Brunton added that self-managed super fund investors in particular could be caught out by the current environment of falling interest rates due to the exposure to cash and term deposits (TDs).
“We see a lot of investors using term deposits and hybrids within their fixed income or within the defensive part of their portfolio. We suggest that TD rate will be under downwards pressure this year as we expect the [Reserve Bank of Australia] to take cash rates to 2 to 2.5 per cent,” he said.
“You may not realise that now but when you come to roll your TD in 12 or 24 months’ time, the income that’s going to be there for you is going to be very different to what it was in the last few years.”
Mr Brunton said a bond is a natural place for those investors to switch into because it has already had those falls imputed into the yield of the bond, which is likely to be able to outperform TDs.
