EU corporates at risk of cash-flow crisis in 2021; Global sovereign debt market; U.S./EU sectors: Hunting for weak links of the investable universe

Thanksgiving marks the beginning of the year-end holiday period, a time to take stock of past developments and to look at the longer-term impact of events: We are, therefore, looking at the funding gap that could open up for many Eurozone corporates in the new year if fiscal policy support were to be discontinued; On the other hand, we analyze how sustainable the global sovereign debt market is in the long run. And we identify the sectors within the investable universe that have the most promising risk-return profile. And the ‘cherry on the icing’: A batch of updated country & sector reports (speaking about Thanksgiving without mentioning food at least once proved difficult). Enjoy!

Europe: One in four corporates will need more policy support in 2021 to avert a cash-flow crisis

The first wave of Covid-19 lockdowns caused a stronger-than-expected profitability shock for most European non-financial corporates in H1 2020, with French and Spanish firms hit particularly hard despite generous policy support. Now, with the second wave of lockdowns, we expect a heavy cost for Covid-19 sensitive sectors across the Eurozone, which could see average operating losses of -15% to -20% in 2020 compared to pre-crisis levels. In the absence of prolonged fiscal policy support or an aversion to taking on more debt, this could dry up cash buffers, putting around 24% of Eurozone companies (or more than 4.1 million) at risk of a cash-flow crisis next year. One out of four companies in Germany and France are directly exposed to the Covid-19 sanitary restrictions vs. one out of five companies in Belgium and the Netherlands. In total, the combined turnover of exposed companies exceeds EUR 4,3trn and they account for more than one out of four workers, notably in Spain and Italy, or close to 19 million persons. As we estimate the drop in revenues to reach up to -20% on average in the Eurozone the impact on companies' cash balances will be unprecedented. And the current surge in excess corporate cash, equivalent to untapped cash resources available for future investment purposes or debt repayments, sparked by state-guaranteed loans won’t be enough to compensate for loan repayments and the delayed tax repayments by mid-2021. Moreover, we currently expect governments to take a much more cautious approach to exiting the lockdowns to allow time for a vaccination campaign for people at risk to reach a critical level and avoid a third wave. This means that activity in H1 2021 could prove slower to recover compared to Q3 2020. Hence, policy measures need to address the funding gap for companies stuck between a loss of revenue and mandatory expenses such as taxes and financial debts.

Find our comprehensive analysis here.

Global sovereign debt market: Not seeing the trees for the forest

In response to the Covid-19 shock, global public debt will hit an all-time high of 130% of GDP or USD 277trn in 2020, exceeding even the levels seen during the Second World War. This won’t be without consequences for debt sustainability, particularly for the most fragile economies in the European periphery. The Covid-19 crisis has sparked a strong and globally synchronized increase in public debt, particularly in advanced economies, to smooth the negative impact of lockdowns. At the same time, central banks have pursued unconventional monetary policies, mainly involving government bonds purchases, with their balance sheets converging above 50% of GDP at the end of 2020. This is simultaneously allowing a quasi-direct financing of world public debt. These common factors seem to have compressed risk premiums and created a spirit of complacency regarding the sustainability of world public debt. The central question is whether the deviation from a common trend of debt accumulation leads to a widening of government bond spreads. To study this question, we build a model allowing us to identify the common and specific determinants of debt issuance across countries to see if only the specific components (that we could associate with a deviation from a trend of higher public debt at a global level) have an influence on government spreads. The first conclusion is that the common factor of public debt supplies is significant for all countries in explaining sovereign spreads, with higher beta for the European periphery. The second conclusion we draw is that the U.S. 10-year interest rate has a higher impact on European spreads than national specific factors of debt. The third conclusion is that specific factors of the U.S. and Germany’s public debt supply are strongly significant in explaining all EMU sovereign spreads. Finally yet importantly, specific factors of periphery countries’ public debt have a low explanatory power in explaining spreads, meaning that those countries could face high difficulties in stabilizing their government bond yields even when being determined to stabilize public debt.

Please find our full report here.

U.S. & Eurozone sectors: Hunting for the weak links

When it comes to traded corporate credit, some sectors have attracted larger inflows than others: Automobile, retail, healthcare and consumer goods have reversed most of the spread widening experienced during the peak of the pandemic. Following our proprietary market risk indicator (including EQ and Corporate Credit market moves) we derive that U.S. markets currently perceive oil & gas, travel & leisure and banks to be the most risky and least appealing sectors. Interestingly, automotive, technology, retail and personal goods are the sectors perceived to be less risky or, in other words, the most crowded sectors. A similar pattern to that of the U.S. can be observed in the Eurozone. For both the U.S. and the Eurozone, it is clear that travel & leisure and oil & gas are in extremely bad shape as they are currently not generating enough cash flows to cover their interest payments. However, even in this deteriorated situation markets are still mispricing the threat to both sectors as their corporate credit spreads remain extremely compressed due to both central bank and investors’ interventions. On the other side of the coin, technology and retail come out as the winners of the fundamentals and market sentiment race, which brings worries about those sectors being overcrowded. From a long-term investment perspective, it looks appropriate to optimize the risk-return profile by avoiding the sectors at the extremes and focusing on the more resilient part (the middle) of the investable universe.

You can find our full analysis here.

Updated country and sector risk reports

Our country and sector risk assessments will help you to better understand the risks in international trade:

Chemicals sector: Rated M (medium risk for enterprises): Wounded but not sunk given the dependence on automotive and construction

Malaysia: Rated BB2 (medium risk): Basis for a robust growth outlook, but beware of downside risks.

Thailand: Rated B2 (medium risk): Recovery slowed by the slump in tourism.

Philippines: Rated B2 (medium risk): Fragile and slow economic recovery.

Iceland: Rated B2 (medium risk): Slowdown ahead as tourism falters.

Azerbaijan: Rated D4 (high risk): Covid-19 reveals structural vulnerabilities in an environment of political instability.

Bosnia-Herzegovina: Rated D4 (high risk): Covid-19 has increased external financing risk.