Emma Wall: Hello, and welcome to the Morningstar series "Market Reaction." I'm Emma Wall and I'm joined today by Paul O'Connor, Head of Multi Asset for Henderson, to talk about Europe.
Hello, Paul.
Paul O'Connor: Hi.
Wall: So, yesterday Mario Draghi's corporate bond buying programme began. What has been the market reaction?
O'Connor: It's had a very big impact on conditions in corporate bond markets. If you look at how corporate bonds were behaving in the year and the run-up to this being announced in March, the conditions were very difficult. We saw spreads widening. We saw liquidity conditions were quite tricky. We saw primary issuance began to slow and all of this changed quite dramatically in March when Draghi unveiled their corporate bond buying programme.
What we've seen since then is spreads narrowing. We've seen yields come down. The yield on investment-grade in Europe is now below 1% and we've seen a massive surge in issuance. So, companies are now able to extend the maturity of their debt and lock in these lower yields. So, it's been a very positive impact so far.
Wall: I suppose then the question is, is it too late for investors to feel any of the upside because central bank policy across the world at the moment seems to be they like to give us a long run-up to any of these policies being introduced. They don't like to shock the market. But it does mean, as you say, that since March the market has been rising and yields have been falling. So, now, is there any upside left?
O'Connor: Well, it's a good question because it has been the phenomenon that we've seen with a lot of these monetary policy interventions is, markets have bought the rumor and then sold the fact. And we've seen a very big move in this one so far. I'd say we've seen the best in terms of the capital returns, particularly in the corporate bond market where we've seen very unusually large returns in such a short period of time. But I feel the markets are underpinned.
So, I think if you're buying corporate bonds here, you have to expect fairly low returns, but you should also expect fairly low volatility as well, because to an extent I think we could see the ECB underpinning the market here, but I don't think we can expect to see the same kind of yield shift again. If investment-grade bonds yield 1%, there's not a lot of further downside we can expect.
Wall: Of course, he is buying bonds or rather, central banks are buying bonds, but it's not just the bond market that is affected, is it? The equity market should see some positives from this?
O'Connor: It should do. I don't think it's seen them so far. If you look at how equity markets behaved in the December ECB meeting and the March one, both times equities sold off in the wake of the meeting. And although credit markets were euphoric with what happens in March, equity investors are contending with slow growth globally. They were disappointed about the euro going up after the ECB meetings. Equities like a weaker euro. And they were concerned about some of the adverse impact of these policies on the banking sector, particularly the impact of negative interest rates.
So, for now, equity markets have not been that impressed by the policy, particularly the corporate bond buying programme. I think as we look further down the road we should expect it to be more positive. It should boost corporate profitability. Companies can get their interest rate build on. That should boost corporate earnings by 4%, 5%, 6%. It should make European equities attractive from an asset allocation point of view.
As an asset allocator, I'd see investment-grade bonds are 1% and I can buy good-quality European dividend yields at 3% to 4% and ultimately, I think it should change corporate behavior. If you're on the corporate sector, you see your debt is quite expensive, your equities are very cheap. It should encourage you to buy back your own shares and ultimately, it should encourage M&A as well. So, I'd say, in the short-term, the equity market hasn't been that impressed, but it should be a big medium-term support.
Wall: And of course, those concerns that you alluded to that are in the equity markets remind us that although this Eurozone recovery is underway, it's not yet out of the woods. I mean, we've even had Greece rear its ugly head again recently. So, how concerned are you about the Eurozone recovery?
O'Connor: So, I mean, it feels in terms of the macroeconomics as if we're skating on thin ice this year. We're making progress but there's lots of worries. Greece is one. I think Greece is not a big worry. The Finance Minister's met basically kicked the can down the road yet again. And I think the next big decision to be made in Greece will probably be after the German elections in the second half of next year, but it's out there as a longer-term concern.
I think the big one is growth, is global growth. And if we look at Europe, European growth has actually been quite resilient. The forecasts have been quite stable in the last few months. They were edging up through most of last year. But of course, you look everywhere else, we're seeing big downgrades. Forecasts for 2016 growth for the U.K., for Japan, for the U.S. as well, are all a lot lower than they were at this time last year. And so far the European recovery has been able to withstand this, but I think if we saw any further weakness, particularly in the U.S. economy, that would be a problem.
Wall: Paul, thank you very much.
O'Connor: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
