Look to corporates as Europe heals

The euro crisis is slowly fading away but not all is cured in Europe. While some may be convinced that the worst has come and gone, issues will continue to resurface that will shake investor confidence in coming months.

Patrick O’Toole, vice-president of global fixed income at CIBC Asset Management, asserts that Europe is far from healed. Major problems are still evident in Greece, recipient of the latest bailout and restructuring, as sovereign bonds continue to trade at suppressed levels.

Spain and Portugal are in the spotlight currently, and one or both may need an assistance package over the next twelve-month period.

O’Toole expects continued volatility from Europe, affecting bonds, stocks and risk appetites in general. While markets are currently in a sweet spot due to the European Central Bank’s long-term refinancing operations (LTRO), which have injected much-needed liquidity in the European market, the region’s underlying long-term problems haven’t been solved.

“Europe still has a very shaky banking system,” says O’Toole. “You’ve got poor banks propping up poor countries and poor countries propping up poor banks. It’s a vicious circle and to remedy the situation, more time and more healing will have to take place.”

The LTRO does buy time, though, and helps create a more solid foundation for overall growth. Lending will resurface and start accelerating again, as is already happening in the U.S. The eurozone has more time to get to that same stage, in O’Toole’s opinion.

The corporate bond market has been particularly strong over the past few years and will continue to be an attractive sector of the bond market for investors. Corporate bonds have been overweight in CIBC’s client portfolios, including both investment-grade bonds and high-yield sector bonds. The bank considers both areas attractive for the Canadian and U.S. bond market in coming years.

“Corporate bonds as a long-term investment are very beneficial for clients since corporate bonds beat government bonds over the longer term,” says O’Toole. “There are certainly episodes, seen last year for example, where corporate bonds lag. But over the medium- and long-term, you want to have an allocation to these products in your portfolio.”

The fundamentals of corporate bonds are positive as well. Corporate Canada has very low debt-to-equity outside of the non-financial sector at the moment and leverage is very low.

While credit spreads have contracted since the depths of the financial crisis, they remain very wide on a historical basis. This reflects persistent underlying global risks, which are affecting investor sentiment and putting them on edge, but risks are being accounted for.

“Corporate spreads are still decently paying investors for current market risks. It’s a good time to get involved from a valuation perspective and also in the light of the health of corporations in Canada,” says O’Toole. “Investment-grade and high-yield sector bonds will add value to your clients’ portfolios.”