CreditSights: Taking Stock At Halftime
As we close in on the end of the first six months of 2004 it is interesting to compare trends in the first half of the year with that of the latter six months. Is it more typical for spreads in the second half of the year to follow the trend set by the first six months? Looking at data in the investment- grade arena over the last seven years, there have only been two periods when spreads in the second half of the year reversed the trend established between January and June.
In 1997, a minimal tightening in the first half of the year was followed by a modest widening in the second half. And in 2001 the market rallied substantially into June by experienced a modest widening into the end of the year. Interestingly, in two of the years (1999 and 2002) there was little discernible movement in spreads in the second half of the year at all. The pattern is by no means definitive but there is enough repetition to suggest that it is unusual for investment-grade spreads in the second half of the year to pull an about-face on first-half direction. Nor was there much variation from this pattern in the high-yield sector. The magnitude of spread moves was greater, but there was the same tendency for spreads in the second-half of the year to continue in the direction set in the first half.
If this pattern is to be repeated in 2004 it shall make for very quiet market conditions in the coming months, despite the major developments in the macro fundamentals. Such an environment should be conducive to investors returning to the high-beta trade as the carry becomes all the more important given the lack of available capital appreciation, but as we noted yesterday, investors still seem to show preference (verbally at least) for a more defensive positioning. Outperforming by overweighting the investment-grade sector will prove difficult if spreads remain becalmed and the situation will not be helped if primary market volumes continue to fall.
Another area where first-half/second-half patterns can be reviewed is issuance. In the high-grade sector issuance volumes have historically showed a slight bias to the first half, but it is a trend that is accelerating and in the last three years, close to 60% of the year's total volume had been issued by the end of June. In 2002 this reached an extreme of 64%. In 2004 to date, investment-grade volume is less than $160 billion, a level that is low enough to be causing major portfolio challenges for investors generally and index managers especially. Should this prove to be close to 60% of the year's total, then second-half issuance will actually be just $100 billion, much less than most current forecasts. In such a scenario issuance would fall short of redemptions and coupon payments by some $35 billion, greatly exacerbating the existing management hurdles.
In the high-yield sector there is historically greater variation in the issuance patterns but even here the recent historical pattern suggests that second-half volumes will be lower in the coming six months.