The Long and Short
A fast start despite challenging fundamentals
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Emerging markets debt looks likely to keep luring investors looking for yield, with spreads still wide of pre-pandemic levels. And EM issuers are responding. January marked the most active month for EM debt issuance on record, with some deals between 4x and 8x oversubscribed. Some new deals are immediately repricing in the secondary market one point to two points higher. Despite investor appetite, the earnings season is starting to show that some sectors face challenging fundamentals.
The EMBI Global Index’s most recent spread of 319 bp still stands wide of its pre-pandemic February 2020 tights of 288 bp. EMBI Global Index returns so far this year have come in at -1%.
In the EM debt primary market, January 2021 marked the most active bond issuance month on record with US$121 billion compared to US$112 billion in January 2020, according to Bond Radar. This is also almost five times the total bond issuance in December 2020 (US$25 billion). Within January’s issuance pie, Asia represents 50% and Latin America about 25%, with US$30 billion of new issuance and a year-end target for Latin America of US$75 billion. As things go this number will likely be surpassed during the first half of 2021.
Issuers are taking advantage of low US Treasury yields, despite the recent moves and curve steepening, and massive hunger for yield across the globe. On the more technical side, Latam high yield corporate debt new issues are often 4.0x to 8.0x oversubscribed, with bonds breaking into the secondary market one point to two points higher above issue price. On the other hand, issuers and their syndicate banks are pushing spreads 50 bp to 100 bp tighter from original issuance price guidance, leaving less room from compression and some disappointment. Some of this very tight HY ‘B’ issuers look likely to be the first ones to sell-off during a correction. Latam HY corporates that outperformed recently (+3-4pts) tend to be small issues (US$500 million) and include Crédito Real, Atento, Banco Industrial, Ammagi. Still, most of the new wave of issues—mostly issued to take out callable bonds—are trading above par.
Reporting season just started, which usually lasts two months in Latam. Earnings expectations for the fourth quarter of 2020 are a mixed bag, as most Latam countries experienced sharp recessions in 2020 with GDP down 5% to 10%. Many are still going through the pandemic with limited vaccination programs in place. Sectors that should perform well during earnings include steel, mining, agribusiness, pulp and paper, all linked to exports and China. On the other hand, sectors with expected weaker results include industrials, transportation, oil and gas, consumer, financials and utilities, all linked to domestic GDP and a reflection of an uncertain recovery environment. It will be healthy to start seeing some credit differentiation based on fundamentals, as the current high tide in credit valuations hides some of the fundamental weaknesses in various companies.
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