Steffen Ullmann
Senior Portfolio Manager – Investment Grade
The upcoming reporting season is an important indicator of whether current company valuations are still justified in the context of a disappointing European economy.
A disappointing European economy, but silver lining on the horizon
The recent increase in profit warnings from issuers on the European bond market also confirms the European Central Bank’s (ECB) assessment that economic activity is developing more weakly than expected.
In particular, the weakness in the manufacturing industry and the slowdown in the service sector are weighing on the economy. Private consumption is declining, the increased uncertainty is leading to postponed consumer decisions and thus to a savings rate of almost 15.7% in the second quarter of 2024, which is well above the historical average of 12.9%. [1]
Nevertheless, there are also positive signs. China is – still – pursuing a cautiously expansive fiscal policy, which could stimulate the German economy in particular. The cycle of interest rate cuts that has begun in Europe and the USA should also have a positive impact on the economy in the medium term.
BBB bonds: A historical classification
In this environment, it makes sense to reassess the attractiveness of BBB bonds. With a current risk premium of 113 bp below the historical median (as at 21.10.2024), the BBB segment offers lower yield potential than at the beginning of the year. This is because the risk premium in the BBB segment has fallen by 26 bp since then, significantly more than the 11 bp for the A segment[2]. At first glance, this makes the BBB segment appear unattractive. However, it still offers a level of resilience that should not be neglected. One indicator of resilience is the “break-even spread”. This determines the spread increase up to which an excess return over government bonds can be expected with an investment horizon of 12 months. This is currently 25 bp for the BBB universe – above the median of 23 bp[3].
Source: Bloomberg, I10362EU Index (Bloomberg Euro-Aggregate: Industrials Baa), own presentation, as at 21.10.2024
Balance sheet strength: tipping the scales
Most issuers continue to have robust balance sheets behind these valuations. The difficult macroeconomic situation in Europe did not have a significant impact on corporate balance sheets in the first half of the year. In addition to the low level of debt – a result of the disciplined balance sheet restructuring following the coronavirus crisis – profitability remained at a high level (as at 30/09/2024). Both are also reflected in the observed positive rating migration from high yield to investment grade and from BBB to A bonds. The upcoming reporting season with the latest corporate figures and initial indications for 2025 will show whether this robustness will be maintained.
Conclusion
Despite the challenging macroeconomic environment and lower risk premiums, BBB bonds continue to offer attractive yield opportunities. However, a stronger focus on individual company developments is required again. The upcoming reporting season is therefore an important indicator.
[1] Source: “Statement on monetary policy – Press conference”, European Central Bank (17.10.2024)
[2] Source: Bloomberg, I10362EU Index (Bloomberg Euro-Aggregate: Industrials Baa) and I10359EU Index (Bloomberg Euro-Aggregate: Industrials A), as at: 21.10.2024.
[3] Source: Bloomberg, own calculation for the period 2013 to 2024, as at: 21.10.2024.
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