Indexology^® Blog

2015 was a difficult year for emerging markets, as investors reduced their exposure to emerging markets and some shifted to developed markets. With concerns about a growth slowdown, a strong U.S. dollar, and the plunge in oil prices continuing to linger, some investors have remained cautious about allocating their exposure to emerging markets.
Looking specifically at the Southeast Asian local debt markets, there is evidence that they have shown resilience when compared with the equity markets; for example, the S&P BSE 500 (TR) climbed 0.45% in 2015, while the S&P BSE India Bond Index rose 8.40% in the same period.
As tracked by the S&P Pan Asia Bond Index, the bond markets in Malaysia, Singapore, Indonesia, India, and Thailand all delivered positive returns last year. In fact, these countries have demonstrated robust growth trends since the index was incepted on Dec. 29, 2006 (see Exhibit 1).

Exhibit 1: Total Return Performance of the Southeast Asian Sovereign Bond Indices

Looking at index performance YTD, the S&P Indonesia Bond Index had a strong start and gained 4.54%, outperforming other Southeast Asian bond indices, which increased by 0.5%-1.5%. As presented in Exhibit 2, the yield-to-maturity of most countries has come down a bit in the past two years, which is in line with the global bond markets.  As of Feb. 10, 2016, the yield-to-maturity of the S&P Malaysia Sovereign Bond Index stood at 3.49%, and its sovereign debt is rated as ‘A-‘ and ‘A3’ by Standard & Poor’s Ratings Services and Moody’s, respectively.

Exhibit 2: Current Yield-to-Maturity of the Southeast Asian Sovereign Bond Indices

It’s no secret commodities have been struggling in 2016 adding pressure to their greatest catastrophe in history. While much of this is from energy, with a year-to-date loss of 24%, the S&P GSCI Non-Energy is only down 1.4% for the year. Further, the precious metals sector in the index is up 17.4% year-to-date. Now that is something to love, and they aren’t the only commodities posting gains this year. Seven commodities are positive year-to-date including gold +17.7%, silver +14.4%, lean hogs +6.6%, zinc +5.9%, lead +2.0%, soybeans +1.1% and corn +0.4%. In honor of Valentine’s Day, below is a poem I wrote to give them the love they deserve.

I hope you enjoyed something fun and light with this gift from me to you. Happy Valentine’s Day!

• In January, foreign investors rotated positions back into UDIBonos, adding about 1.2% market share—a significant allocation to this investor base.
• Flows into government bonds as a whole remain muted—in net, foreign investors withdrew about MXN 9 billion over the same period. (CETES: decreased MXN 32 billion; MBonos: increased MXN 7 billion).
• January inflation surprised analysts at 0.38% vs. expectation of 0.28% according to the Banamex survey released on Feb. 5, 2016. Additionally, the survey shows that analysts expectation for full year 2016 inflation to be at 3.07%.
• UDIBonos performance has lagged: current breakeven-inflation levels are below analysts’ expectations for inflation.

Throughout most of 2015, inflation in Mexico surprised analysts with its downside, finishing the year at a historical low of 2.13% (year-over-year).  By mid-year 2015, foreign investors began to pare back exposure to inflation-linked UDIBonos, which they had been allocating aggressively to over the 12-month period prior.  While foreigners are not the dominant price setters for UDIBonos, the reduction in position, which amounted to about 3% (May-December 2015) of market share, or MXN 37 billion (using the average UDI/MXN), weighed on performance of the inflation-linked instruments.

It is worth noting that although net foreign flows into government bonds have been muted, investors rotated out of both nominal and real rates, adding to bills (Chart pack available on request) and keeping exposure to Mexican pesos.

Over the year, average UDIBonos yields, as measured by the , were up 110 bps, eroding coupon and inflation carry on the bonds, leading to a 1.8% loss in terms of total return in pesos.  This is compared to yields on MBonos (nominal bonds), as measured by the S&P/Valmer Mexico Sovereign Bond Index, which moved up only 32 bps, with the index returning 4.3%, buoyed by its coupon carry.

As of January 26, 2016, foreign investors added MXN 15.7 billion (UDI 2.9 billion) YTD to UDIBonos and MXN 7 billion YTD to MBonos, while they reduced CETES positions by MXN 32 billion.  Although the addition to UDIBonos doesn’t seem outsized in cash terms, we note that foreigners own about 60% of the MBonos market, versus 11% of the UDIBonos market.  This highlights the important increase in relative terms to allocations in the inflation-linked bonds.  Both MBonos and UDIBonos have benefited, as yields have declined by as much as 50 bps on UDIBonos and 30 bps on MBonos.

The relative performance leaves break-even points only marginally wider and below the 3% handle.  January 2016 inflation in Mexico surprised analysts at 0.38%, versus the expectation of 0.28% (Banamex survey), with base effects driving the year-over-year figure to 2.61% from 2.13% in December 2016.  Although seasonality of inflation (February-March) warrants caution, year-end inflation is expected to rise to 3.1% (Banamex survey), while break-even points calculated using the June-2022 bond from the S&P/Valmer Mexico Sovereign Bond Index versus June-2022 bond from the S&P/Valmer Mexico Government Inflation-Linked UDIBONOS Index are pricing 2.7%, or 37 bps, below current year-end inflation expectations.

Germany and Luxembourg government bond yields have tightened nearly 30 bps since the beginning of 2016, moving the S&P Germany Sovereign Bond Index and the S&P Luxembourg Sovereign Bond Index yields back into negative territory (see Exhibit 1).  Yields on both indices last hit negative territory in April 2015, at the height of the Greek debt crisis.  Swiss government bonds have been consistently negative since January 2015, and the S&P Switzerland Sovereign Bond Index is has tightened 22 bps since the beginning of 2016.

Due to the inverse relationship between yields and prices, while yields are negative the performance of these indices is positive.  As of Feb. 8, 2016, performance of the S&P Switzerland Sovereign Bond Index was one of the highest in the eurozone, at 3.4% YTD; the S&P Germany Sovereign Bond Index came in at 3.04% YTD, and the S&P Luxembourg Sovereign Bond Index returned 1.70% YTD (see Exhibit 2).

Fears over the financial health of some of the larger European banks and the volatility in the stock market are causing risk aversion and are leading some investors into the relative safety of European government bonds.  This, coupled with indications that the ECB might increase its QE program in March, could be setting the stage for continued negative yields with positive performance in this “safe” asset class.

The year 2016 appears to have gotten off to a similar start to the beginning of 2015.  The S&P 500^® Bond Index has returned 0.92% as of Feb. 8, 2016, while in 2015 the index was up 1.57% as of Feb. 8, 2015.  Maybe the month of February will end up being more similar than investors might want.  The yield-to-worst of the S&P 500 Bond Index ended February 2015 13 bps wider than where it began the month.  The same might be true this year, as the yield of the index, at 3.55% as of Feb. 8, 2016, is almost even to January’s 3.56% so the question is whether yields widen out from here as they did last year.

By now, many have heard the news go on about the lower prices of oil and materials.  The S&P 500 Energy Corporate Bond Index has lost 3.71% YTD, followed by a 0.87% YTD drop in the S&P 500 Materials Corporate Bond Index.

Unlike recent index performance, January’s and February’s spread widening has crept into industry sectors other than energy and materials.  Excluding energy and materials, the largest changes in option adjusted spread (OAS) to U.S. Treasuries have been seen in the telecommunication services (up 51 bps) and consumer discretionary (up 41 bps) sectors.

Exhibit 1: OAS History of the S&P 500 Bond Index Industry Sectors

Source: S&P Dow Jones Indices LLC.  Data as of Feb. 8, 2016.  Past performance is no guarantee of future results.  Chart is provided for illustrative purposes.

Related to the widening of the industry sector spreads is the widening of the credit rating indices.  Of note is that the current OAS level of 235 bps for the S&P 500 BBB Investment Grade Corporate Bond Index has risen close to the starting point of 287 bps seen back in June 2015 for the S&P 500 BB High Yield Corporate Bond Index.

Exhibit 2: OAS History of the S&P 500 Bond Index Rating Categories

Source: S&P Dow Jones Indices LLC.  Data as of Feb. 8, 2016.  Past performance is no guarantee of future results.  Chart is provided for illustrative purposes.

Source: S&P Dow Jones Indices LLC.  Data as of Feb. 8, 2016.  Past performance is no guarantee of future results.  Table is provided for illustrative purposes.