(Bloomberg) -- It’s the season for investment banks to try to predict the future in credit markets. The ritual is trickier than usual this time.
Rarely have they been so divided by a rally that seems to defy economic gravity -- and those disagreements aren’t just from firm to firm, they’re between strategists on the same team.
“Where we are now is looking for a catalyst for a turning point, which is always challenging,” said Deutsche Bank AG strategist Nick Burns.
The strategists know their year-end outlooks could come back to haunt them. There’s the unpredictable White House and fiscal agenda, and the Federal Reserve and European Central Bank are unwinding or slowing down bond-buying programs.
Morgan Stanley (NYSE:MS) and Deutsche Bank (DE:DBKGn) issued bearish projections at the end of 2016, only to see global corporate and high-yield bonds return 6 percent as the credit rally extended another year.
With spreads on U.S. and euro-area corporate bonds close to post-crisis lows -- leaving little margin for error -- the challenge is to acknowledge the positive backdrop while hedging for the downside risks.
Deutsche Bank took the novel approach of publishing the calls of each member of its credit team before positing the house view. Germany’s biggest bank sees a buoyant first half and then a change in the second half, when declining central bank stimulus eventually pressures corporate debt’s tight valuations.
“In markets so lacking in volatility it’s interesting to point out where we are different,” said Burns.
Bank of America Merrill Lynch (NYSE:BAC) and JPMorgan Chase & Co (NYSE:JPM). see room for the rally to continue, citing ample global liquidity and aggressive risk appetite. Morgan Stanley, HSBC Holdings Plc (LON:HSBA) and Societe Generale (PA:SOGN) SA, on the other hand, find little to like in a crowded market late in the business cycle.
“There’s a real lack of conviction,” said David Riley, who helps oversee $57 billion of assets as head of credit strategy at BlueBay Asset Management LLP in London.
“At the macro level, at current spreads, a few days’ market move wider can wipe out a year’s carry,” the HSBC team led by Steven Major told clients last week. “At the micro level, just a couple of leveraged buyouts or fallen angels could ruin 2018 performance.”
It’s easy to see why there’s little consensus. Growth is picking up, keeping a lid on corporate defaults and leverage. Yet asset values are “extraordinarily inflated,” according to BlueBay’s Riley, himself a credit bull. And there’s the wildcards of central banks reining in quantitative easing.
“A lot of strategists keep coming back to the issue around valuations but can’t see what would be the catalyst whereby you get a very dramatic or violent repricing given we have this positive global macro outlook,” Riley said.
Cycle End
Geof Marshall, the guardian of $40 billion of assets at CI Investments’ Signature Global Asset Management in Toronto, says this is symptomatic of a peaking business cycle.
“The dispersion of forecasts -- a bit of tightening, a bit of widening -- is consistent with low levels of volatility,” Marshall said. “This worries me.”
Earlier this year, strategists at Bank of America Corp. admitted they “were running out of ideas in credit,” underscoring the challenge of touting high-conviction trading calls after a long and steady rally.
“It feels like everyone is wrestling with how long this credit cycle can last,” said CI’s Marshall.
BlueBay’s Riley, at least, doesn’t blame strategists if they get their calls wrong.
“Those outlooks have a short shelf life,” he said. “Stuff happens.”
(Adds Deutsche Bank strategist quote to third paragraph.)