With AAA-rated euro government bond yields still negative out to 20 years’ maturity, European bond investors seeking income and return potential must consider higher-yielding alternatives. But they need not look far—euro high-yield (HY) markets continue to be attractive on valuation, fundamental, and technical grounds.
Spreads have widened recently to around 360 basis points giving the market a yield of around 3.0%, a worthwhile pickup over lower-risk euro sovereign bonds (Display, left scale). Meanwhile, as European economies have started to recover from the COVID-19 pandemic, corporate earnings and cash flows are rebounding. Fundamentals are improving for euro HY companies across a range of metrics—notably, net leverage, interest cover and earnings before interest, taxes, depreciation and amortization (EBITDA) margins. This trend strengthens corporate balance sheets and increases HY issuers’ resilience. And although the latest COVID-19 Omicron variant may slow the improving trend, we don’t believe it will impact the low level of HY defaults we are forecasting for next year. Default rates in HY companies have fallen sharply since February, and we believe they will continue to trend down (Display, right scale). Notably, euro HY remains a relatively high quality market, comprising over 70% BB-rated bonds.
Further, the European Central Bank (ECB) is committed to supporting the euro-area economy via a range of measures. These include keeping interest rates ultra-low and buying investment-grade (IG) securities. These purchases keep yields down in the IG market and accentuate the potential attractions of HY for higher income and total return. And since rising inflation isn’t the pressing concern in Europe that it is in the US, interest-rate hikes in the eurozone are likely still distant.
Europe remains the clear leader in the rapidly-growing HY ESG market, with a 50% share of US$51 billion issuance in the first nine months of 2021 (according to Morgan Stanley and Barclays respectively). We believe rising investor interest in green and sustainable bonds will provide a further technical tailwind for the euro HY market.
Euro HY is a specialized market where credit selection is of paramount importance. With disparate rates of economic recovery across sectors and across the region, the euro HY market continues to offer opportunities for active investing. The time is right for investors to take a second look.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time.