SOCGEN: The good times are coming to an end in 2018

Go home, good times, you’re drunk. Photo: Scott Barbour/ Getty Images.
  • Societe Generale economists and credit strategists forecast a slowdown in the US economy to begin in 2019 or 2020.
  • This year has been marked by a strong earnings recovery and resilient economy, two things that have fuelled investor interest in buying risky corporate bonds.
  • But as the Federal Reserve and the European Central Bank stop their own bond buying, the credit market will be more vulnerable, Societe Generale strategists forecast.
  • Economists at other firms, including Morgan Stanley and Guggenheim, have also forecast that 2018 could represent a peak for this cycle.

The party’s almost over, Societe Generale strategists say.

A strong earnings recovery and a growing economy have fuelled investor interest in buying risky corporate bonds this year.

Societe Generale’s credit strategists see 2018 as a transition year for the credit market, with the low-yield environment that has driven some investors into riskier credit instruments likely to turn.

“We expect 2018 to see the last of the good times, with very positive conditions early in the year,” the strategists Juan Esteban Valencia and Guy Stear said.

“In our view, the ultra-low yield environment will remain in place, making credit a very attractive proposition, even at current levels. Additionally, economic growth should remain healthy and the CSPP (and QE program) should remain supportive of the asset class. However, at some point, we expect these idyllic conditions to start shifting.”

By stopping their bond-buying programs, the European Central Bank and the Federal Reserve would leave credit, including the market for government bonds, more vulnerable to market movements, according to SocGen.

Global credit already looks overvalued, the strategists said. Sustained demand for riskier corporate bonds has reduced the spread between their yields and comparable government bonds to the lowest levels in three years.

Screen Shot 2017 11 29 at 2.09.07 PMSociete Generale

A previous study they conducted showed that the level of spreads explained about half of the following year’s performance. “Low spreads are the mother of negative excess returns,” they said, adding that credit markets would start 2018 on the wrong footing with tight valuations and low breakevens.

Screen Shot 2017 11 29 at 2.21.31 PMSociete Generale

Like Societe Generale’s credit strategists, the firm’s economists see a risk that the US economy starts to slow down in 2019 or 2020 amid lower profit margins. Economists at other firms including Morgan Stanley and Guggenheim have also underscored their year-ahead outlooks with warnings that 2018 could represent a peak.

That matters to credit investors because weak growth coincides with rising credit spreads, the strategists said.

“We believe the US and the eurozone are heading for an economic slowdown in 2019,” they said, “and given the rising levels of corporate leverage, this should have an impact on credit.”

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