Embed Size (px)
Citation preview
Global Economic and Investment Outlook
A delicate balance
Q1 2018
2 Global Economic and Investment Outlook – Q1 2018
Overview: A delicate balance
The global economy enters the new year firing on all cylinders. The US economy
is growing at a healthy pace, Europe growth continues to surprise on the upside, and
China’s economy ended last year up nearly 7%.
Demand for yield remains strong. With inflation subdued, risk free rates have
remained low, encouraging risk taking and a search for yield.
This “Goldilocks” environment has been asset price supportive, with major equity
benchmarks hitting all time highs and credit spreads near pre-crisis lows.
However, monetary policy is tightening and asset valuations leave little room for
disappointment. With the US economy near full capacity and fiscal policy turning more
expansionary, the Fed is expected to accelerate rate hikes and its withdrawal of liquidity
from the bond market. The ECB will slow and then halt its QE program.
This delicate balance puts investors in a difficult positon. Strong growth
fundamentals and still low risk free yields argue for continuing to allocate to risk assets.
However, market pricing leaves little scope for disappointment or policy errors.
Although market correction risks are rising, recession is unlikely in 2018 and
broad corporate default risks will remain low in our view.
We do not think investors should shun risk assets in this environment. However,
defensive businesses, protective structures, and strategies that are able benefit from
idiosyncratic sector, company and security specific opportunities are preferred.
Contents
Overview: A delicate balance. . . . . . . . . . . . . . . . . . . . . . . . . 2-4
Summary of macro and market views. . . . . . . . . . . . . . . . . . 5-6
Market views . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7-11
− US high yield - Strong fundamentals, but market risks rising
− US private debt - Steady gearing, rising equity cushion
− Europe high yield - Supportive macro fundamentals
− Europe private debt - Structural tailwinds intact
− Macro Views . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . 12-16
− US – As good as it gets?
− Europe – Still in a sweet spot
− UK – The UK buys itself a reprieve – but it’s unlikely to last
− China – Positive growth surprise in 2017, but slower growth ahead
Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17-18
− Market performance tables
Nicholas Brooks
Head of Economic and Investment Research
+44 203 201 7934
Edward Cuschieri
Associate
+44 203 201 7755
Synchronised growth and earnings recovery has boosted markets
30
40
50
60
70
80
90
100
110
120
-8
-6
-4
-2
0
2
4
6
8
07 08 09 10 11 12 13 14 15 16 17
World Production Growth (LHS)
World EPS (MSCI World)YoY %
2007
Q1=100
Source: Bloomberg and World Bank
3 Global Economic and Investment Outlook – Q1 2018
A delicate balance
But the industrial cycle has likely peaked. Global industrial production
rose strongly last year, with purchasing manager indexes (PMIs) surging to
multi-year highs. The industrial cycle is by definition cyclical and it is rare for
growth to remain at current elevated levels for an extended period of time.
China’s influence over the cycle has increased as its global economic clout
has risen. As illustrated in the chart below, it appears that there is a long lead
relationship between China’s credit cycle and the global industrial cycle (as
proxied by the US manufacturing ISM).
Improving employment supporting private consumption
Strong earnings growth supporting investment rebound
As we move into 2018 markets are in delicate balance. On one side strong economic
growth, healthy earnings and low interest rates are supportive of risk taking and
higher asset prices. On the other side, however, are asset valuations that leave very
little room for disappointment, tightening global monetary policy and growing
geopolitical and policy risks. What does this mean for asset allocation?
Given strong underlying growth and corporate fundamentals we would not shun risky
assets. We expect the credit cycle to remain positive, with system wide default rates
in major developed economies to remain low. However, we think it is likely that
market volatility will move higher and market correction risks will rise. In this
environment we would put a higher than usual premium on selectivity in investment
exposures. Defensive businesses, protective structures, and strategies that are able
benefit from idiosyncratic sector, company and security specific opportunities rather
than broad market beta are preferred.
Recession risk is still low. We enter 2018 with strong growth momentum. The IMF
is now forecasting global growth of 3.9% in 2018 and 2019, the fastest global growth
in 7 years. The US, Eurozone and China economies are all outperforming
expectations. A global earnings pick-up is supporting an upswing in the investment
cycle. Strong employment markets are supporting private consumption. We therefore
think recession risk in 2018 is low and that the credit cycle will remain positive.
Source: Bloomberg
Source: Bloomberg
Summary and implications for asset allocation
Slowing China credit growth indicates industrial cycle may have peaked
Source: Bloomberg
YoY % Index Level
44
46
48
50
52
54
56
58
60
-25
-20
-15
-10
-5
0
5
10
15
20
10 11 12 13 14 15 16 17 18 19
China Credit Impulse (Advanced 15mths)
US Manufacturing ISM (RHS)
-10
-8
-6
-4
-2
0
2
4
6
8
10
30
40
50
60
70
80
90
100
110
120
07 08 09 10 11 12 13 14 15 16 17
World Earnings Per Share growth
OECD Fixed Investment YoY (RHS)
YoY % 2017 Q1=100
0
2
4
6
8
10
12
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
US Unemployment Rate Germany Japan%
4 Global Economic and Investment Outlook – Q1 2018
China’s credit impulse1 has slowed sharply over the past 18 months as measures
have been put in place to slow the rapid growth of non-financial sector corporate
borrowing (mostly state-owned enterprises). Indications are the authorities plan to
implement further tightening measures this year in order to stabilise what many
view as an unsustainable debt burden. The risk is that this tightening ultimately
causes a weakening of the industrial cycle later this year with negative implications
for current bullish global growth and earnings forecasts.
Source: Bloomberg
US 10-year yield and the industrial cycle
Source: Bloomberg
Policy rates will remain low. The Fed is the main exception, with three 25bp
hikes expected in 2018. US tax cuts are coming at a point when the US economy
is already growing above estimated potential and employment conditions are
materially tightening. When combined with a weak dollar and sharp rise in the oil
price, inflation will likely pick up this year and the Fed will react. The Eurozone and
Japan, however, are further behind the US in the cycle and inflation pressure is still
muted. Strong currencies will provide a further drag on inflation. The ECB will
likely end its quantitative easing (QE) program in 2018, but its policy rate will stay
steady at -0.4%. Japan will likely continue to anchor its 10-year government bond
yield at 0% and its short-term interest rate at -0.1%
Long govt bond yields rising – but increases likely to be contained
Positive outlook, but market correction risks are rising. Summing it up, we
believe that the global economy is currently well-supported, with strong
employment, earnings and now recent US tax cuts potentially adding to both
growth and earnings. Interest rates in the US may rise, but rates in the world’s
other two major advanced economy blocs are likely to remain low. Systemic
financial sector risks are relatively low, with banks balance sheets substantially
enhanced over the past ten years. Cyclical and market correction risks,
however, are growing. Asset valuations are high relative to history, credit
spreads are near pre-crisis lows and current market consensus is highly bullish
the outlook. Some might argue it has become complacent. This does not leave
much room for disappointment or policy error in our view.
has not been as strong as most of the bond bears assume. In fact, since the
crisis there has been a stronger relationship between the US 10-year yield and
the US manufacturing ISM than with inflation (see chart below). If we are correct
and the industrial cycle begins to wane later this year – and/or tax cut stimulus
does not boost growth as much as is currently anticipated, long yields are likely
to fall. The retraction of QE by the Fed and expected increase in government
borrowing has the potential to exert upward pressure on long yields. However,
the Fed has made it clear that if the reduction of its bond buying were to disrupt
markets, it will intervene (i.e. slow or halt its balance sheet reduction) if
necessary. With the Fed focused on rising inflation, short rates will likely remain
elevated, pushing the yield curve lower. Historically, during Fed rate hike cycles
the yield curve has flattened, with nine of the past twelve rate hike cycles
culminating in recession. The US is still in the early stages of its rate hiking
cycle, but this is a risk to watch as we move into 2019.
1China credit impulse is annual growth in new lending as a % of GDP.
45
50
55
60
65
1.0
1.5
2.0
2.5
3.0
3.5
4.0
10 11 12 13 14 15 16 17
US 10Y Yield US Manufacturing ISM (RHS)% Index
level
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
15 16 17 18
US Govt 10Yr Yield Germany Govt 10Yr Yield
UK Govt 10Yr Yield Japan Govt 10Yr Yield%
Bond yield increases will be contained, yield curve will flatten. Global
government long bond yields have recently followed US yields higher, with a
number of analysts calling for an extended bond bear market. In our view
this is unlikely. The relationship between US long bond yields and inflation
5 Global Economic and Investment Outlook – Q1 2018
Market views – Continued strong fundamentals in 2018, but market volatility likely to rise
USD high yield bond and leveraged loan market spreads¹
1. Data as of 30 Sept 2017, asset classes represented by the following indices: BAML HCNF (US HY) S&P LLI (US Leveraged Loans), BAML HPID (EUR HY), S&P ELLI (EUR Leveraged Loans). Further details and definitions of the indices are provided in the index disclaimer in the notes section. 2LTM = Last twelve months.
EUR high yield bond and leveraged loan market spreads¹
Source: S&P, BAML as of 31 Dec 2017.
USD and EUR high yield total returns¹ Asset Class Market Views and Outlook
US
High Yield Bonds
US high yield shrugged off Fed rate hikes, returning a
robust 7.3% in 2017. Strong macro data and earnings
growth were key drivers of performance. However, with
spreads near pre-crisis lows, the Fed stepping up
tightening and QE retracting, volatility and correction risks
are rising in 2018 in our view.
Leveraged Loans
US leveraged loans returns rose a healthy 4.1% in 2017.
A continued strong US macro backdrop is expected to
support corporate fundamentals in 2018, with consensus
expecting defaults to remain below 3%. With rates rising
and the potential for higher volatility in 2018, we tend to
prefer loans over high yield bonds in the current
environment.
Private Debt
With PE dry powder reaching another record high and
company fundamentals still positive, the market remains
well supported. Strong demand continues to push EVs
higher, but equity cushioning remains at all time highs.
Deal selectivity and careful structuring remain particularly
critical in this environment.
Europe
High Yield Bonds
Europe HY continued to perform well in Q4, with returns
up 6.3% in 2017. Strong economic growth should support
corporate fundamentals and keep default rates low.
However, with spreads near pre-crisis lows and the
potential for higher volatility in 2018 as the ECB reduces
QE, we tend to prefer loans over debt at a broad market
level.
Leveraged Loans
European loans returned a healthy 4.5% in 2017 as
strong interest payments drove returns. Europe’s
recovery is supporting company fundamentals, with the
default rate only 1.1% in 2017. We expect defaults to
remain low in 2018 and anticipate strong fundamentals
will drive positive returns for the year.
Private Debt
Dry powder remains at high levels, keeping large
sponsored deal competition strong and valuations high,
further increasing the premium on careful deal selection
and structuring. Despite high valuations, large equity
buffers, positive growth and corporate fundamentals point
to steady returns ahead.
US Q4 2017 LTM2
3 years
(annualised)
5 years
(annualised)
HY 0.4% 7.3% 6.3% 5.6%
Loans 1.1% 4.1% 4.4% 4.0%
Europe Q4 2017 LTM
3 years
(annualised)
5 years
(annualised)
HY 0.6% 6.3% 5.9% 6.4%
Loans 0.6% 4.5% 4.8% 5.3%
350
450
550
650
750
850
15 16 17
US HY
US LeveragedLoans
250
300
350
400
450
500
550
600
650
700
15 16 17
EUR HY
EUR LeveragedLoans
6 Global Economic and Investment Outlook – Q1 2018
Macro views – Solid growth in 2018, cyclical risks are rising
Chart sources: IMF, Bloomberg
IMF now forecasting global growth to pick-up in 2018
Inflation still mostly well below target
Govt bond yields currently rising, but likely to be capped
Global macro views and outlook
Global Outlook The IMF again revised up its global forecasts, putting 2017 growth at 3.7% and forecasting 3.9% growth in 2018 and 2019, the strongest growth since 2011. The Fed is accelerating the retraction of QE and the ECB is likely to end QE this year. The combination of less monetary accommodation and a moderation of the industrial cycle later this year increases market correction risks, but we expect economic growth to remain positive and broad credit default rates to remain low.
US US growth continues to surprise on the upside and the passage of tax cuts is expected to provide a boost to near term growth. Inflation is likely to start rising moderately in 2018 and the Fed is expected to raise rates 3 more times. QE retraction of $450bn is expected. Bond market volatility is likely to rise, but long govt yields unlikely to rise sharply on a sustained basis and yield curve to flatten.
Euro Area The Eurozone economy continues to perform well, with GDP up 2.4% in 2017, its highest growth rate since 2007. Company profits are increasing and default rates steady at low levels. Political risk is contained, with Eurosceptic views reduced. Italy’s 4 March election may result in a weak coalition government, but efforts to shore up Italian banks have reduced near term risks. The ECB is expected to keep its target rate flat and to prepare market for and end of QE by year end.
UK In Brexit negotiations, the UK agreed to most of the EU’s demands on financial payments, the Irish border and EU citizens’ rights, potentially opening the way for a two year transition period lasting until end 2020. Although the potential reprieve has shored up the pound and equities, a positive agreement is far from assured and economic data has continued to disappoint.
China China growth surprised on the upside in 2017, rising 6.9% as positive net exports and consumption helped offset slower investment. We expect the clampdown on non-bank financing will be stepped up in 2018, leading to more moderate growth with potential surprise knock-on effects on the global economy. Sharp slowdown and systemic financial risks remain low, however, in our view.
Japan Japan continues to perform well, with 2017 GDP growth up an above potential 1.7% on improving investment and exports. This trend is expected to continue in 2018 as Olympic investment picks up. The BoJ will maintain an accommodative stance, targeting a 10yr govt yield of 0% and maintaining its QE program.
Asia ex-Japan The region has benefited from the rebound in the global manufacturing cycle and the wealth effect of rising markets. Inflation is contained, keeping most central banks on pause. Stable growth and continued low rates are likely.
Australia/NZ Australia GDP is expected to come in a solid 2.4% in 2017 and grow at a similar pace in 2018 as low unemployment and rising earnings support demand. RBA to remain on hold. New Zealand is also expected to show steady growth.
-1
0
1
2
3
4
5
6
08 09 10 11 12 13 15 16 17
US Govt 10Yr YieldGermany Govt 10Yr YieldUK Govt 10Yr YieldJapan Govt 10Yr Yield
%
-5
-3
-1
1
3
5
96 98 00 02 04 06 08 10 12 14 16 18
World GDPUS GDPEuro Area GDP
YoY %
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
07 08 09 10 11 12 13 14 15 16 17
US Core PCE Inflation Eurozone Core Inflation
UK Core Inflation Japan Core InflationYoY
Table Legend: Arrow direction represents economic growth trend. Colour represents growth relative to respective
developed or emerging market average growth rate as per IMF WEO. Green=above average, Amber=in-line, Red=below.
Global, relative to own 2 year average.
Market views
US high yield - Strong fundamentals, but market volatility risks rising
US private debt - Steady gearing, rising equity cushion
Europe high yield – Supportive macro fundamentals
Europe private debt – Structural tailwinds intact
Global Economic and Investment Outlook – Q1 2018 7
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
US HY
US Leveraged Loans
$0B
$25B
$50B
$75B
$100B
$125B
$150B
Jan2017
Feb2017
Mar2017
Apr2017
May2017
Jun2017
Jul2017
Aug2017
Sep2017
Oct2017
Nov2017
Dec2017
Loans Bonds
0
500
1000
1500
2000
2500
3000
05 06 07 08 09 10 11 12 13 14 15 16 17
US LeveragedLoans
98
108
118
128
138
148
158
US HYUS Leveraged Loans
Issuance robust but refinancing activity slows
8 Global Economic and Investment Outlook – Q1 2018
US high yield – Strong corporate fundamentals, but market volatility risks rising
US Loans and HY returns continued to rise in Q4 2017, with leveraged loans adding
1.1% over the quarter vs HY returns of 0.4%.This brought 2017 returns for the loan
market to 4.1% and 7.3% for high yield debt. Market sentiment was helped by the
passing of US tax cuts, strong macro and earnings data. We expect macro and
corporate fundamentals to remain positive in 2018, though volatility risks are rising in
our view, leading us to generally prefer loans over bonds.
Strong HY debt and loan issuance continues, with the seasonally quiet quarter
finishing just below Q3 levels ($195bn vs $210bn). 2017 Loans issuance was the
largest on record, fuelled by a buoyant CLO market that continued through Q4.
Spreads tightening but still off pre-crisis lows
Default rates set to fall further this year
Source: S&P LLI, BAML 31 December 2017
1. Source: BAML HCNF and S&P LLI., please see further detail and definitions of the indices in the index disclaimer in the Notes section. 2.S&P LCD. 3. Barclays, Lipper. 4. Moody’s estimates. 5. S&P LCD News based on new issuance minus
repayments minus CLO issuance and Prime Fund inflows.
Source: S&P Global Market Intelligence, Dec 31 2017; S&P/LSTA Leveraged Loan Index.
Moody’s Default Report.
Positive returns continue
Source: S&P LLI, BAML 31 December 2017
Acquisition-related financing slowed in Q4, but likely temporary.
According to LCD acquisition financing slowed to $25bn in Q4, the lowest
level for private equity backed acquisition financing since Q4 2015. Dividend
and refinancing volumes were steady over the quarter though, with $11bn and
$15bn coming to market respectively. Barring a financial shock, healthy
economic growth, tax-driven capital repatriation, low financing costs and high
asset valuations will likely drive acquisition activity higher in 2018.
Corporate fundamentals remain positive. Loan defaults ended the year at
2.3% vs 2.8% in 2016 and HY at 3.3% vs 5.6% in 2016. Strong economic and
EBITDA growth are expected to push default rates lower in 2018.
Source: S&P Global Market Intelligence, 31 December 2017; S&P/LSTA Leveraged Loan Index
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
0bps
50bps
100bps
150bps
200bpsSpread per unit of leverage EBITDA/Cash Interest
Large LBO purchase prices continue to rise
9 Global Economic and Investment Outlook – Q1 2018
US private debt – Steady gearing, rising equity cushions
Private debt raised a record level of funds in 2017. Investor demand for private
debt exposure continues to rise as asset managers try to meet return targets in the
face of low yields and high valuations across traditional asset classes.
US private equity dry powder hit a new high in Q4 2017. Dry powder for US PE
buyout and distressed funds reached nearly $450bn in 2017, with an increase of
$18bn in Q4 alone. Deal flow and demand for private debt financing are likely to
continue to rise in 2018, especially if favourable macro conditions persist.
US Private equity dry powder hits a new all time high in 2017 US private debt dry powder rises as fund-raising picks up
Interest coverage continues to hold firm
Source: Preqin; Dry powder for private equity buyout funds and distressed PE as of 31 Dec 2017. Source: Preqin, capital raised and dry powder for direct lending, mezzanine, distressed
debt & special situations funds. As at Dec 2017
Source: S&P as at Q4 2017, EBITDA of €/$ 50M or more Source: S&P as at Q4 2017, All deals. EV=Enterprise value.
LBO multiples rose further in 2017. LBO multiples pushed higher in Q4 as
strong deal competition and high global asset prices pushed prices higher.
Leverage, however, increased only modestly as equity funding has increased,
keeping equity cushioning well above pre-crisis levels.
Interest coverage remains healthy, gearing stable on continued low interest
rates and positive EBITDA trends. Cover remains well above pre-crisis levels,
though spreads relative to leverage continue to compress. Gearing at an
aggregate level has remained relatively stable over the past three years.
$0bn
$20bn
$40bn
$60bn
$80bn
$100bn
$120bn
$140bn
$160bn
$180bn
04 05 06 07 08 09 10 11 12 13 14 15 16 17
Funds raised
Dry Powder Private Debt
4.9x 5.5x 5.6x 6.2x 5.2x 4.0x 4.7x 5.2x 5.3x 5.4x 5.8x 5.7x 5.5x 5.8x
2.5x 2.7x 3.0x
3.7x 4.3x
3.9x 3.8x 3.9x 3.6x 3.4x
3.9x 4.4x 4.5x 4.6x 7.4x
8.2x 8.6x 9.8x 9.5x
7.9x 8.5x
9.1x 8.9x 8.8x 9.7x 10.1x 10.0x 10.4x
0.0x
2.0x
4.0x
6.0x
8.0x
10.0x
12.0x
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
DEBT/EBITDA Equity/EBITDA EV/EBITDA
$0bn
$50bn
$100bn
$150bn
$200bn
$250bn
$300bn
$350bn
$400bn
$450bn
$500bn
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
98
108
118
128
138
148
158
168
EUR HY
EUR Leveraged Loans
Europe leveraged finance volume highest in ten years - driven primarily
by refinancing as spreads tighten. December issuance in the European loan
market was the highest on record, pushing total leveraged finance volume in
2017 to its highest level in ten years. While volumes were similar to those in
2007, the make-up of financing is very different, with 53% of 2017 volume for
refinancing (vs 16% in 2007%) and 30% for acquisitions (vs 65% in 2007). We
anticipate acquisition financing will increase in 2018.
Strong Q4 makes 2017 a record year for high yield issuance
10 Global Economic and Investment Outlook – Q1 2018
European high yield markets – Supportive macro fundamentals
Continued positive returns. High yield debt and leveraged loan returns rose in Q4,
bringing 2017 returns to 6.3% and 4.5% respectively. Europe remains in a sweet spot
in our view, with rising economic growth and continued low interest rates supporting
corporate fundamentals and investor flows.
Default rates remain low and are expected to fall further. Europe’s high yield
default rate remained broadly stable at 2.6% in 2017, with Moody’s forecasting it will
fall as low as 1.2% this year. Leveraged loan defaults fell to a record low of 1.2% in
November, the 5th consecutive month of no defaults.
Europe HY and leveraged loans continue to perform well Spreads continued to tighten over the year
Default rates remain low and are declining
Source: BAML, S&P ELLI to 31 December 2017 Source: BAML, S&P ELLI to 31 December 2017
Source: S&P Global Market Intelligence, 31 Dec 2017; S&P/LSTA Leveraged Loan Index. Source: S&P Global Market Intelligence, 31 Dec 2017; S&P/LSTA Leveraged Loan Index. Moody’s
Default Report – data to 31 Dec 2017.
1. Source: BAML HCNF and S&P LLI. please further detail and definition of the indices are provided in the index disclaimer in the Notes section. 2.S&P LCD.
€0B
€5B
€10B
€15B
€20B
€25B
€30B
€35B
Dec2016
Jan2017
Feb2017
Mar2017
Apr2017
May2017
Jun2017
Jul2017
Aug2017
Sep2017
Oct2017
Nov2017
Dec2017
Loans Bonds
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
EUR HY
EUR Leveraged Loans
0
500
1000
1500
2000
2500
3000
05 06 07 08 09 10 11 12 13 14 15 16 17
EUR HY
EUR Leveraged Loans
4.6x 5.3x 5.6x 6.3x 5.2x
4.1x 4.4x 4.5x 4.3x 4.7x 5.2x 5.0x 4.9x 5.6x
3.0x 3.0x 3.2x
3.4x 4.4x
4.8x 4.8x 4.4x 5.1x 4.0x 4.4x 4.1x 5.1x 4.7x
7.6x 8.3x
8.8x 9.7x 9.6x
8.9x 9.2x 8.8x 9.3x
8.7x 9.7x
9.2x 10.0x 10.2x
0.0x
2.0x
4.0x
6.0x
8.0x
10.0x
12.0x
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Debt/EBITDA Equity/EBITDA EV/EBITDA
Source: S&P as at Q4 2017, EBITDA of €/$ 50M or more
LBO price remain high with equity contributions at high levels
11 Global Economic and Investment Outlook – Q1 2018
Europe private debt – Structural tailwinds intact
Europe PE dry powder holding near historic high. PE dry power rose to $207bn in
2017, just $5bn below the 2016 record high. This has continued to drive strong deal
flow and demand for private debt financing. We expect continued healthy economic
growth, stable corporate fundamentals and the search for alternative returns will keep
PE activity (and PD demand) high in 2018.
Private debt funds raise $32bn in 2017 just below 2015 record levels. Demand for
PD in Europe continues to grow as investors widen their mandates into alternative
asset classes to diversify and boost risk adjusted returns. Despite strong deployment,
stronger fund raising pushed dry powder to a record $63bn.
Europe private equity dry powder remains near record high Private debt fund raising and deployment is strong
Spread per unit of leverage remains comfortable, interest cover up
Source: S&P as at Q4 2017, EBITDA of $ 50M or more. EV=Enterprise value.
Source: Preqin; Dry powder for private equity buyout funds and distressed PE as of Dec 2017. Source: Preqin, capital raised and dry powder for direct lending, mezzanine, distressed debt & special situations funds. As at 31 Dec 2017
LBO purchase multiples generally continue to push higher. Leverage has
increased at the large sponsored level - but equity cushioning remains
substantially higher than pre-crisis levels. Bilateral direct private lending and
sponsorless niche mezz have managed to maintain tighter discipline, with less
pronounced increases in leverage and generally better pricing than larger LBO
deals.
Corporate fundamentals remain positive. Revenue and EBITDA grew at a
fast pace in 2017. This and continued low interest rates has kept interest
cover and spread per turn of leverage well above pre-crisis levels. We expect
EBITDA growth to remain strong in 2018.
$0bn$20bn$40bn$60bn$80bn
$100bn$120bn$140bn$160bn$180bn$200bn$220bn$240bn
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
$0bn
$10bn
$20bn
$30bn
$40bn
$50bn
$60bn
$70bn
04 05 06 07 08 09 10 11 12 13 14 15 16 17
Funds raised
Dry Powder PrivateDebt
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
0bps
20bps
40bps
60bps
80bps
100bps
120bps
140bps
Spread per unit of leverage EBITDA/Cash Interest
Macro views
US – As good as it gets?
Europe – Still in a sweet spot
UK – The UK buys itself a reprieve – but it’s unlikely to last
China – Positive growth surprise in 2017, but slower growth ahead
Global Economic and Investment Outlook – Q1 2018 12
13 Global Economic and Investment Outlook – Q1 2018
US – As good as it gets?
US economy continues to fire on all cylinders. The US economy accelerated into
the end of 2017, with GDP up around 2.3% in 2017 vs 1.5% in 2016 and
unemployment falling to a 16 year low. The strong growth fed through to corporate
earnings, with S&P 500 EPS up an estimated 11% in 2017. Continued strong
employment and corporate earnings growth should underpin US growth and the credit
fundamentals through 2018.
But a lot is priced in and expectations are high. While fundamentals appear sound,
much good news is priced in, with consensus forecasting EPS growth of 15% in 2018
and GDP to rise by 2.6%, with US tax cuts estimated to add around 0.3 percentage
points (pp) to GDP and 5pp to EPS. Given stretched market valuations, there is little
room for disappointment.
Investment boosted by strong earnings growth
Private consumption supported by improving labour market
Inflation remains low, but starting to pick up
Source: Bloomberg Source: Bloomberg
Source: Bloomberg. Shaded area=recession, circled areas = Fed tightening ahead of a recession. Source: Bloomberg
Fed overtightening remains the main risk to the outlook
Capacity is tightening and inflation picking up. With capacity and labour
utilisation rising back towards 2007 levels, the oil price up over 25% vs the 2017
average and the US$ down nearly 10% in trade-weighted terms, inflation is
likely to start to pick up (gradually) in the coming months.
Fed overtightening risk rising. The market and Fed “dot plot” now expect 3
more rate hikes in 2018. Meanwhile Fed QE retraction will amount to $450bn in
2018. A risk to watch is that just as rising equity prices and tight credit spreads
pro-cyclically boosted the economy, reversal may have an opposite
compounding effect through higher capital costs and wealth effects. Nine of
the past twelve Fed tightening cycles have ended with recession (see chart
below). The Fed is still early in this cycle, but investors need to be vigilant.
-40
-30
-20
-10
0
10
20
30
40
-30
-20
-10
0
10
20
30
05 06 07 08 09 10 11 12 13 14 15 16 17
Capital Goods New Orders (LHS)
S&P 500 Earnings Growth (RHS)YoY % YoY %
-15
-10
-5
0
5
10
15
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18
US retail sales US retail sales ex food & autos
YoY %
1.0
1.5
2.0
2.5
3.0
13 14 15 16 17 18
US Core PCE Price IndexUS CPI Ex Food and EnergyAverage Hourly Earnings
YoY %
-10
-5
0
5
10
15
20
25
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
US GDP (LHS) Fed Funds RateYoY %, bps
14 Global Economic and Investment Outlook – Q1 2018
Europe – Still in a sweet spot
Eurozone economy continues to outperform expectations. GDP is estimated to
have increased by around 2.4% in 2017, its highest growth rate since 2007.
Unemployment continues to fall, supporting private consumption, and rising company
earnings are supporting a rebound in investment.
Corporate fundamentals remain strong. Company profits are increasing (Eurostoxx
50 EPS up 12% in Q4 ) and default rates remain steady at low levels, with Moody’s
forecasting speculative grade default rate will fall to 1.1% by end 2018 from 2.8% in
2017. Positive corporate momentum should support hiring and investment growth.
Eurozone growth momentum remains strong
Corporate fundamentals are improving with the economy
Inflation under control, with strong Euro an added dampener
Source: Bloomberg Source: Bloomberg.
Source: Bloomberg. Source: Bloomberg.
Europe rates to remain low
Political risks unlikely to derail expansion. While Italy’s 4 March election
looks likely to result in a weak coalition government, anti-Euro sentiment has
subsided and last year’s interventions to shore up Italian banks have reduced
near term risks. Brexit related market volatility remains a concern but will likely
be contained to the UK.
ECB preparing market for QE end, but low inflation should anchor rates.
The ECB hinted at possible change to forward guidance, indicating a higher
chance QE ends in Sept. While this may put modest upward pressure on bond
yields, with core CPI weak and the Euro rise likely to keep it that way, a rate
hike is still a long way off.
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
10 11 12 13 14 15 16 17 18
Eurozone Core CPI
Eurozone CPI
YoY %
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
60
70
80
90
100
110
120
130
02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18
Eurozone Economic Sentiment Indicator
ECB Industrial New Orders Ex Heavy Transport
EU Real GDP YoY (RHS)
YoY % Index Level
-2
-1
0
1
2
3
4
5
07 08 09 10 11 12 13 14 15 16 17 18
ECB Deposit Facility Rate
Germany 2y Govt Bond Yield
Germany 10y Govt Bond Yield
%
70
75
80
85
90
95
100
105
110
115
120
0
20
40
60
80
100
120
07 08 09 10 11 12 13 14 15 16 17
Europe EPS (MSCI)
Europe Economic Sentiment Indicator
Index Level Index Level
15 Global Economic and Investment Outlook – Q1 2018
UK – The UK buys itself a reprieve – but it’s unlikely to last
UK capitulation on Brexit “divorce” terms buys a reprieve – but unlikely to last. The
UK agreed to most of the EU’s demands on financial payments, the Irish border and EU
citizens’ rights, potentially opening the way for a two year transition period lasting until
end 2020. It is hoped that this transition period will be agreed at the EU summit in March.
Relief at the potential for a transition period has shored up the pound and equities.
However with agreement far from assured given deep divisions in the UK government and
economic data continuing to disappoint, the reprieve may be short-lived.
Economy continues to be dragged down by Brexit uncertainty. Retail sales have
been weakening, with lacklustre wage growth combined with higher import prices hurting
spending power. Weaker residential property prices have also weighed on sentiment.
UK retail sales continue to weaken
Brexit uncertainty is weighing on residential property market
But healthy employment levels reduces recession risk
Source: Bloomberg Source: Bloomberg
Source: Bloomberg Source: Bloomberg
Inflation likely to fall, keeping BoE rate hikes on hold
But recession risks remain low. Despite the UK’s economic
underperformance, a recession in the near term seems unlikely.
Unemployment is holding near a 40 year low, providing a floor to private
consumption. Purchasing manager surveys (PMIs) are underperforming those
of Europe and the US but remain expansionary. Barring a large external
shock, growth should remain positive.
BoE likely to hold off on further rate hikes as CPI peaks. The BoE
rationalised its rate hike in December on higher inflation. However, with CPI
now peaking as the FX effect fades out and growth data weakening, it seems
likely the BoE will take a wait and see approach to further hikes from here.
-6
-4
-2
0
2
4
6
8
10
09 10 11 12 13 14 15 16 17 18
UK Retail Sales Volume ex-Auto Fuel (3mma)
UK Retail Sales Volume ex-Autos
YoY %
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
8.5
9.0
28,500
29,000
29,500
30,000
30,500
31,000
31,500
32,000
32,500
07 08 09 10 11 12 13 14 15 16 17
UK Total Employed (LHS)
UK Unemployment Rate (RHS)‘000 %
-20
-10
0
10
20
30
40
-1
0
1
2
3
4
5
6
07 08 09 10 11 12 13 14 15 16 17 18
UK CPI
UK PPI Imported Input Prices Advanced 3mths (RHS)
YoY % YoY %
-20
-15
-10
-5
0
5
10
15
20
-70
-50
-30
-10
10
30
50
70
05 06 07 08 09 10 11 12 13 14 15 16 17 18
UK RICS New Buyer Enquiries (advanced 9mths)UK Nationwide House prices YOY % (RHS) YoY % Net balance
16 Global Economic and Investment Outlook – Q1 2018
China – Positive growth surprise in 2017, but slower growth ahead
Strong GDP growth but signs momentum is slowing
Tighter credit is slowing import growth . . .
. . . and cooling off China’s property market
Source: Bloomberg. 2Li Ke Qiang Index comprised of growth of loans, electricity production, rail freight.
Source: Bloomberg. 1Credit impulse = growth of net new loans as percent of GDP.
Source: Bloomberg
Weak US$ continues to support China FX reserves and currency
China economy grows faster than expected in 2017. GDP rose 6.9% in 2017 up
from 6.7% in 2016, with stronger than expected net exports the main driver of the
upside surprise. China disproportionately benefited from the synchronised rise in
global industrial cycle in 2017, with rising exports offsetting a policy induced slowing of
fixed investment.
But further tightening measures are likely in 2018. With corporate (mostly SOE)
debt estimated to have risen to 260% of GDP in 2017, policy-makers will likely
continue to implement measures to slow property and bank off-balance sheet lending
and allow more defaults and investment losses to encourage rational market-based
allocation of resources.
Weakening credit impulse points to slower growth ahead. As policy-
makers have cracked down on off-balance sheet and property lending,
China’s credit impulse1 has weakened. Historically China’s credit impulse
has correlated well with imports and has been a good long lead indicator of
global industrial cycle.
FX risks remain low (for now). China FX reserves have increased for
eleven consecutive months now as the weak US$ and tightened capital
controls have stemmed outflows. The reduction in pressure on China’s
balance of payments removes (for now) one key threat to China and global
financial stability.
-10
-5
0
5
10
15
20
25
30
35
06 07 08 09 10 11 12 13 14 15 16 17 18
China 1st tier city property prices
China 2nd tier city property prices
China 3rd tier city property prices
YoY %
0
5
10
15
20
25
30
0
2
4
6
8
10
12
09 10 11 12 13 14 15 16 17
China Real GDP (LHS)China Li Ke Qiang Index2China M2 growth
YoY % YoY %
90
92
94
96
98
100
102
104-100
-80
-60
-40
-20
0
20
15 16 17
China FX Reserves - monthly change
US$ Trade Weighted Index (RHS. Inverted Scale)US$bn US$ TWI
-15
-10
-5
0
5
10
15
-20
-15
-10
-5
0
5
10
15
20
Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
China Import Growth (volume)China Credit Impulse (RHS)
YoY % YoY %
Source: Bloomberg
APPENDIX
Global Economic and Investment Outlook – Q1 2018 17
US Dec 2017 Q4 2017 LTM 3 years
(annualised)
5 years
(annualised)
HY 0.3% 0.4% 7.3% 6.3% 5.6%
Loans 0.4% 1.1% 4.1% 4.4% 4.0%
Europe
HY 0.0% 0.6% 6.3% 5.9% 6.4%
Loans 0.0% 0.6% 4.5% 4.8% 5.3%
18 Global Economic and Investment Outlook – Q1 2018
US and Europe High Yield Performance Table
Please note:
1. Data as of 31 Dec 2017, please further detail and definition of the indices are provided in the index disclaimer in the Notes section.
US and EUR total returns¹
US and EUR Change in Spreads
US Dec 2017 -1 month -3 months -6 months - 12 months
HY 382 bps 0 bps 6 bps -17 bps -62 bps
Loans 405 bps -5 bps -12 bps -12 bps -60 bps
Europe Dec 2017 -1 month -3 months -6 months - 12 months
HY 301 bps 6 bps 11 bps -4 bps -85 bps
Loans 422 bps 9 bps -1 bps 0 bps -71 bps
US and EUR Absolute Yields Levels
US Dec 2017 -1 month -3 months -6 months - 12 months
HY 5.93 5.87 5.55 5.76 6.22
Loans 5.19 5.17 5.19 5.07 5.18
Europe Dec 2017 -1 month -3 months -6 months - 12 months
HY 2.88 2.74 2.69 2.87 3.50
Loans 3.80 3.77 3.87 3.88 4.47
19 Global Economic and Investment Outlook – Q1 2018
Disclaimer
THE MATERIALS BEING PROVIDED TO YOU ARE INTENDED ONLY FOR INFORMATIONAL PURPOSES AND CONVENIENT REFERENCE AND MAY NOT BE RELIED UPON FOR
ANY PURPOSE. THIS INFORMATION IS NOT INTENDED TO PROVIDE, AND SHOULD NOT BE RELIED UPON, FOR ACCOUNTING, LEGAL, TAX ADVICE OR INVESTMENT
RECOMMENDATIONS ALTHOUGH INFORMATION HAS BEEN OBTAINED FROM AND IS BASED UPON SOURCES THAT INTERMEDIATE CAPITAL GROUP PLC ("ICG PLC")
CONSIDERS RELIABLE, WE DO NOT GUARANTEE ITS ACCURACY AND IT MAY BE INCOMPLETE OR CONDENSED. ALL OPINIONS, PROJECTIONS AND ESTIMATES
CONSTITUTE THE JUDGMENT OF ICG PLC AS OF THE DATE OF THE MATERIALS AND ARE SUBJECT TO CHANGE WITHOUT NOTICE. ICG PLC DISCLAIMS AND HEREBY
EXCLUDES ALL LIABILITY AND THEREFORE ACCEPTS NO RESPONSIBILITY FOR ANY LOSS (WHETHER DIRECT OR INDIRECT) ARISING FOR ANY ACTION TAKEN OR NOT
TAKEN BY ANYONE USING THE INFORMATION CONTAINED THEREIN. THESE MATERIALS ARE NOT INTENDED AS AN OFFER OR SOLICITATION WITH RESPECT TO THE
PURCHASE OR SALE OF ANY SECURITY OR INVESTMENT INTEREST AND MAY NOT BE RELIED UPON IN EVALUATING THE MERITS OF INVESTING IN ANY INVESTMENT
INTERESTS. THESE MATERIALS ARE NOT INTENDED FOR DISTRIBUTION TO, OR USE BY ANY PERSON OR ENTITY IN ANY JURISDICTION OR COUNTRY WHERE SUCH
DISTRIBUTION OR USE WOULD BE CONTRARY TO LOCAL LAW OR REGULATION. NEITHER ICG PLC OR ANY OF ITS AFFILIATES MAKES ANY REPRESENTATION OR
WARRANTY, EXPRESS OR IMPLIED AS TO THE ACCURACY OR COMPLETENESS OF THE INFORMATION CONTAINED HEREIN, AND NOTHING CONTAINED HEREIN SHALL BE
RELIED UPON AS A PROMISE OR REPRESENTATION WHETHER AS TO PAST OR FUTURE PERFORMANCE.
THESE MATERIALS (INCLUDING THEIR CONTENTS) ARE CONFIDENTIAL, BEING FOR USE ONLY BY THE PERSONS TO WHOM THEY ARE ISSUED. DISTRIBUTION OF THESE
MATERIALS TO ANY PERSON OTHER THAN THE PERSON TO WHOM THIS INFORMATION WAS ORIGINALLY DELIVERED AND TO SUCH PERSON’S ADVISORS IS
UNAUTHORISED AND ANY REPRODUCTION OF THESE MATERIALS, IN WHOLE OR IN PART, OR THE DISCLOSURE OF ANY OF THEIR CONTENTS, WITHOUT THE PRIOR
CONSENT OF ICG PLC OR ITS AFFILIATES IS PROHIBITED. THIS COMMUNICATION IS LIMITED TO AND DIRECTED TO THOSE PERSONS INVITED TO THE PRESENTATION. IT IS
THEREFORE ONLY DIRECTED AT PROFESSIONAL CLIENTS, AS DEFINED BY THE FINANCIAL CONDUCT AUTHORITY. ANY OTHER PERSONS SHOULD NOT SEEK TO RELY
UPON THE INFORMATION CONTAINED HEREIN. COLLECTIVE INVESTMENT SCHEMES REFERRED TO HEREIN ARE NOT REGULATED FOR THE PURPOSES OF THE UK’S
FINANCIAL SERVICES AND MARKETS ACT 2000 AND ARE NOT AVAILABLE TO MEMBERS OF THE GENERAL PUBLIC. ICG PLC IS AUTHORISED AND REGULATED IN THE
UNITED KINGDOM BY THE FINANCIAL CONDUCT AUTHORITY.
THESE MATERIALS ARE NOT FOR PUBLICATION, RELEASE OR DISTRIBUTION IN AND MAY NOT BE TAKEN OR TRANSMITTED INTO THE UNITED STATES OF AMERICA,
CANADA, JAPAN, SOUTH AFRICA OR AUSTRALIA AND MAY NOT BE COPIED, FORWARDED, DISTRIBUTED OR TRANSMITTED IN OR INTO THE UNITED STATES OF AMERICA,
CANADA, JAPAN OR AUSTRALIA OR ANY OTHER JURISDICTION WHERE TO DO SO WOULD BE UNLAWFUL. THE DISTRIBUTION OF THESE MATERIALS IN ANY OTHER
JURISDICTIONS MAY BE RESTRICTED BY LAW AND PERSONS INTO WHOSE POSSESSION THESE MATERIALS COME SHOULD INFORM THEMSELVES ABOUT, AND OBSERVE
ANY SUCH RESTRICTIONS. ANY FAILURE TO COMPLY WITH SUCH RESTRICTIONS MAY CONSTITUTE A VIOLATION OF THE LAWS OF THE UNITED STATES, CANADA, JAPAN
OR AUSTRALIA OR ANY OTHER SUCH JURISDICTION.
THESE MATERIALS DO NOT AND ARE NOT INTENDED TO CONSTITUTE, AND SHOULD NOT BE CONSTRUED AS, AN OFFER, INDUCEMENT, INVITATION OR COMMITMENT TO
PURCHASE, SUBSCRIBE TO, PROVIDE OR SELL ANY SECURITIES, SERVICES OR PRODUCTS OF INTERMEDIATE CAPITAL GROUP PLC (“ICG PLC”) IN ANY JURISDICTION OR
TO PROVIDE ANY RECOMMENDATIONS FOR FINANCIAL, SECURITIES, INVESTMENT OR OTHER ADVICE OR TO TAKE ANY DECISION.
INDEX DISCLAIMER:
S&P ELLI: STANDARD & POOR’S EUROPEAN LEVERAGED LOANS INDEX (EX-CURRENCY). S&P LLI: STANDARD & POOR’S US LEVERAGED LOANS INDEX HCNF: BAML US
NON-FINANCIAL CONSTRAINED. HPID: BAML EUROPEAN CURRENCY NON-FINANCIAL HIGH YIELD CONSTRAINED.
