Junk Bond Blowouts Have Investors Jittery Over Earnings Season

(Bloomberg) -- Nervousness around the approaching earnings season is causing high-yield investors in Europe to dial down their appetite for risk.

October has already seen two bond blowouts in the secondary market, providing a taster of what may come during the rest of the month. Last week Dutch retailer Hema BV’s notes lost nearly half their value after reporting a decline in quarterly Ebitda. Codere SA followed up that move with a 10-cent drop in its bonds on Tuesday amid lowered earnings guidance for 2019.

“Nobody wants to play the hero,” said Pierre Verle, head of credit at Carmignac Gestion, which manages 37 billion euros ($41 billion) of assets. “It’s an environment of rising risk aversion and we’ll certainly see some volatility in certain names which disappoint in the next earnings season.”

Stagnating economic growth is also seen as a further drag on third quarter results in Europe. Bond issuers in the region “entered an earnings recession in the first half of this year” and the challenging earnings outlook is “likely to constrain the ability of corporates to deleverage organically,” Morgan Stanley strategists said in a client note Monday.

This weakening fundamental picture is already feeding into the rated universe of leveraged borrowers. Moody’s Investors Service said the number of distressed companies rose in the first half of 2019 for the first time in more than two years, and the rating company estimates that default rates for Europe’s high-yield market will almost quadruple to 4.1% by August 2020.

Compounding the reduced appetite for risk is the stellar run that high-yield bonds have already been on this year. Junk-rated corporate bonds have handed investors gains of 8.8% so far in 2019, the highest in five years, according to Bloomberg Barclays index data.

“We are comfortable not adding risk after a 9% rally year to date,” said Andrew Wilmont, a senior investment manager at Pictet Asset Management SA, which manages 165 billion euros of assets. “It’s hard to see the high-yield market being immune to negative macro factors during the next earnings season.”

Single Risks

While renewed central bank stimulus means a broader credit meltdown is unlikely in the near term, those issuers operating in sectors facing structural headwinds may also see bond price declines in secondary.

“We see more pressure on free cash flows for chemicals companies this year due to lower demand for the products oveall, while autos too are posing some big risks, along with construction,” said Benjamin Sabahi, head of research at Spread Research.

As well as industry concerns there are also increasing risks around single names. Thomas Cook Group Plc filed for liquidation in September while Senvion SA and Nyrstar NV are among borrowers to have defaulted on coupon payments this year. Corporate defaults since the beginning of the year rose to 85 last week versus 82 defaults for the whole of 2018, according to S&P Global Ratings.

“We’re seeing more and more companies crash and burn, or face being locked out of the market due to weakening numbers and the economic data is deteriorating,” said Ben Pakenham, deputy head of European high-yield and global loans at Aberdeen Standard Investments, who co-manages about $4 billion of assets. “Ultimately, it will take inflation to kill this cycle, if central banks can’t stand behind the markets then all bets are off.”

To contact the reporters on this story: Marianna Aragao in London at mduartedeara@bloomberg.net;Laura Benitez in London at lbenitez1@bloomberg.net

To contact the editors responsible for this story: Vivianne Rodrigues at vrodrigues3@bloomberg.net, Charles Daly

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