European Credit Strategy
Exit Stage Left Research
Europe
Credit Strategy
Global & European Economic Backdrop: Our base case remains for a tepid,
below trend recovery, an environment actually quite well suited for credit
performance. Yet as credit valuations tighten, risks that the economic picture
shifts in either direction become more meaningful. An upside surprise to
growth, with negative knock-on effects to confidence in liquidity provisions,
investor inflows, and corporate conservatism, is our primary macro concern
The Asset Allocation Picture – Credit in Relative & Absolute Terms
With non-financial spreads still near early-2003 levels, financial spreads wider,
and corporates conservative amidst a low-growth backdrop, we think there
remains a strong case the excess returns over the next twelve months will be
considerably better than average (~60bp). But relative to large cap European
equities, or in total return terms, the asset looks less attractive.
Key Sector Themes: We believe the financial sector remains in the midst of a
multi-year deleveraging trend, with credit a major beneficiary through better
fundamentals (lower leverage) and technicals (more redemptions and less
issuance). Where possible, extending on the financial curve appears a direct
way to play for better banks on a forward basis. Tier 1 remains our preferred
source of portfolio beta, relative to IG corporate cyclicals or High Yield BBs.
Leveraged Finance Trends more Divergent: High Yield remains far from
‘bubble’ territory, but for the first time in a long time, we’re seeing real
divergence of balance sheet trends at the sector level. Be more defensive by
sector (non-cyclical vs. cyclical), but more aggressive by rating (Bs over BBs).
Capital structure pricing remains highly divergent.
Picking Spots in Structured Credit: Structured credit and index options
remain valuable tools for playing dual themes of broader compression with
increased single-name risk, and we highlight preferred strategies.
Table of Contents
1. Summary of Key Trades 3
2. Overview and Macro Backdrop 4
3. The Asset Allocation Case 9
4. Investment Grade Themes 18
5. GBP Credit Themes 27
6. Leveraged Finance Credit Themes 31
7. Structured Credit Trade Themes 38