Debbie King a fixed income manager in Kames’ high yield team believes the fundamentals for the US market are strong with its economic cycle much further along than that of Europe, whilst it is also buoyed by a recovering housing market. The US is also experiencing a pick-up in merger and acquisition activity and this in turn could lead to more leveraged buyouts as the previous deleveraging cycle moves into a re-leveraging phase and more capital investment. However, positive growth is the dominating factor against very early stage corporate activity and should prove supportive for high yield.
Whereas in Europe, King believes talk of the European Central Bank embarking on a quantitative easing streak to ease deflation fears, which would be supportive of high yield, is probably premature.
She says: “The ECB has so far avoided QE despite all the woes the region has endured since the Eurozone crisis began and it is likely to remain a topic of idle conversation rather than serious and imminent policy consideration. However there are still some long term structural problems in Europe and for this reason it is susceptible to more ‘unknown risks’ than the US.”
In terms of valuations King backs her preference for the US saying European high yield markets offer a yield of around 3.7% with an average cash price of just over 106.8 cents in the euro. In the US market the yield is significantly higher at around 5.3% and with an average cash price of 104.4 cents. About 1% of the higher US yield can be explained by the difference in rates markets. However this still leaves a notable spread differential which is attributable to the lower average credit quality rating and longer duration of the US market.
King also points out that although the default outlook in the next few years looks benign in both the US and Europe, the latter represents the greater risk due to its predilection for new issues from untested first-time companies with relatively small earnings and riskier business models.
King says: “Overall the US economic outlook is supportive for corporate health, which should ensure the default rate stays low. The European market is also far less mature than the US, having only been in existence since 2000. The US market is roughly five times bigger, is more mature and enjoys better liquidity.”
