In February, the spread on the iBoxx Euro Corporate Index tightened by 1 basis point to 97 basis points above the government bond curve and 71 basis points over de swap curve. The index earned an absolute return of -0.78%. German 10-year government bond yields closed February at -0.26%, representing an increase of 26 basis points compared to the end of January.

February was a volatile month for credit. In the first two weeks of the month credit performed strongly. The appointment of Mario Draghi as Italian Prime Minister helped market sentiment, as this was not only good news for Italy but also for the European integration in general. Also the economic development remained supportive. Although not great, the manufacturing PMI’s continue to point at growth of the manufacturing sector. This was however consumed by a weaker services segment that continued to decline. Especially the services segments in Italy, Spain, UK and Ireland remain weak, as a result of the strict lockdowns in these countries. Generally speaking the manufacturing sector continues to do well and in both Europe and the US economic data is improving.

Sentiment changed however in the second half of the month. A strong rise in yields resulted in a selloff in credits and as a result an increase in spreads. The rise in yields was caused by expectations of stronger growth and inflation, which in turn increase the probability of monetary tightening by central banks. In Europe the 10-year yield on German government paper increased by 26 bps to -0.26%. In the US the increase in yields was even stronger with an increase of 34 bps to a level of +1.4%. At the end of the month yields did come down a bit after comments by Jerome Powell from the Federal Reserve. He commented on the rise in yields and stated that the Fed would clearly communicate any change in policy. Also the ECB officials reacted by saying that they are watching the bond yields and hinted at the possibility to increase the purchases of government bonds under the PEPP program in order to push yields lower again, as a measure to avoid further tightening of fiscal conditions.

The pandemic continued to have an influence on markets. As per the end of the month John Hopkins reported the number of global fatalities now surpassed the 2.5 million mark. Over the month of February we saw the number of new daily cases slowing compared to the beginning of the year, but with very divergent development between countries. For instance in France the development could result in stricter measures starting early March, whilst in the UK the picture continues to improve. On the vaccine front there was further positive news, as numbers coming from countries with high vaccination rates confirm that the vaccinations are effective. Also the Johnson and Johnson vaccine was approved by the FDA and expectations are that the vaccine will be approved in the EU as well in early March. This increases the prospect of higher vaccination rates in the coming period and improves the chances of a gradual reopening of the economies.

On the fiscal side support remains strong. Resulting in higher growth forecasts, mainly for the US. One of the big reasons for higher growth forecasts in the US has been the Biden stimulus package with a size of 9% of the US GDP. Also the economic data coming out of the US is strong. Retail sales in the US increased by 5.3% over January. Also business activity surveys continue to improve, indicating stronger economic growth. With already 21% of the population vaccinated, the US is clearly ahead of the EU, providing further upside to growth expectations compared to the EU.

Company earnings season is coming to its end. Per end of the month almost 90% of the companies in the US reported and around 70% in Europe. Overall the number of positive sales and earnings surprises in the US has been strong. On average over 80% of the companies in the US surprised positively on earnings. The size of those beats are roughly in line with last quarter at 17%, which is close to the highest on record. Also in Europe companies have, in majority, reported better results than expected. With close to 50% reporting better than expected results they are clearly lagging their US counterparts.

The demand for credit is still strong, despite the relatively low volumes that are bought by the ECB. In February the net purchases done by the ECB under its CSPP program amounted to €3.4 billion in corporate bonds. This was significantly lower than the amount they can buy under the CSPP program and also lower than the €4.9 billion they bought in January. Supply of corporate bonds in February amounted to just €26 billion, with net supply at €10 billion. Sector wise real estate and energy are responsible for a big part of the year to date issuance with in total €13 billion and €16 billion respectively issued this year. Due to the ongoing strong demand for corporate bonds, new issue premiums have been little to non-existent this year relative to this time last year (pre-crisis) when new issue premiums were strong. Many new issues have been priced through their curves. Supply of corporate hybrids is up significantly to €12 billion year-to-date versus €6 billion last year and just €3 billion in 2019. Many corporates continue to issue hybrids to support their ratings and to refinance maturing hybrids. Financials supply was much stronger with €30 billion in supply in February.

In February the travel and leisure sector was one of the better performing sectors. The sentiment improved a bit on the back of a more positive outlook on travel in the medium term. The pathway out of the crisis painted by Prime Minister Boris Johnson resulted in a strong recovery in the credit spreads from airlines. One of the sectors that lagged in February was the automotive sector. The sector is facing relatively big disruptions from a semiconductor shortage. This shortage is a result of overly conservative demand estimates made early last year when automotive OEM’s closed down their plants to cope with the onset of the pandemic. However, as vehicles sales rebounded, contract chipmakers had already allocated production capacity to others, leading to the bottlenecks seen today. Based on sector comments these shortages could continue well into 2Q21. The supply disruptions could result in a 7%-9% lower production rate in the first half of 2021.

During the month, the portfolio’s sensitivity to market trends varied between 105% and 110%. The portfolio therefore held an overweight positioning in terms of market risk.

Our positioning in infrastructure, industrial goods and food & beverage performed relatively well in February. Our position in technology and travel & leisure had a small negative impact on performance.

At individual company level, positive contributions came from the overweight in Frankfurt Airport Becton Dickinson and DSV Panalpina performed relatively well. Also the overweight in Total and underweight in Volkswagen contributed positively. Our underweight in Easyjet contributed negatively as their bonds performed strongly on the back of the improved sector outlook. Our overweight in AT&T suffered as the longer dated bonds underperformed due to the rising interest rate, resulting in steeper spread curves on AT&T.

In February the Fund participated in new deals from amongst others NTT and Cellnex. As new issue premiums are very limited and all in valuations look increasingly stretched, especially on the long end, we take a conservative approach towards participating in new issues.

Outlook
We remain mildly constructive on the market. Although we see the significant positive effect that a working vaccine will progressively have on the economy in the longer term, we do remain concerned on the near term economic growth expectations. We expect economic growth momentum to continue to be weak in the near term, but have a positive view on a 3-6 month horizon with a recovery expected by the end Q2. Especially for the US we have strong growth expectations. This does however increase the risk of a more restrictive monetary policy. Companies remain very much bond holder focussed. This supports the fundamental quality. However after the rally in 2020 valuations are starting to look expensive. Finally, the technical backdrop still remains very robust as a result of the ECB’s willingness and ability to provide liquidity to the government and corporate bond markets combined with limited net supply.