Weekly Credit Strategy Update

Spreads continue to rally

Thu, Apr 17 2008, 14:55 GMT
by Danske Research Team

Danske Bank A/S


Company earnings are weaker but generally in line with analysts’ expectations, resulting in a continued spread rally. We expect worsening fundamentals to weigh on credits but the majority may already be factored in.

Spreads continue to rally

In the past week, credits have continued to rally. European investment-grade credit spreads in iTraxx Europe, have tightened 15bp (-15%), while high yield credit spreads, iTraxx Crossover, have tightened 60bp (-12%). That is, CDS spreads are significantly tighter, while cash bond spreads are broadly unchanged. For more details of the divergence between cash bonds and CDS spreads see next page.

Earnings season provides optimism to credits

The Q1 08 earnings season has so far provided some optimism to credits with earnings from corporates and financials generally in line with analyst expectations. However, US banks are starting to report larger credit losses and not only marking-to-market write-downs, which we see as somewhat worrying. In general, corporates and banks are maintaining 2008 guidance despite the current economic slowdown and financial market turmoil.

Analysts’ earnings expectations have, in fact, been lowered during the last nine months for 2008 and 2009 on the back of lower global growth expectations. Currently the downward revisions have resulted in negative earnings growth (EPS) expectations for Q1, which so far in this earnings season have been confirmed. For the full-year 2008, analysts expect EPS growth to be positive (+14%) but our equity strategists are not convinced that analysts have made large enough downward revisions and they anticipate further reductions of analyst expectations (+4%) as the current economic slowdown unfolds. (Please see their Strategy Briefer published on Friday 11 April for more details, if you need a copy please let us know. In the short term, we believe earnings will continue to drive markets and we expect credits to move in sync with equities. On a longer horizon, we believe the slowing economy, stricter lending standards and higher defaults will weigh on credits but the majority may already be factored in.


Published on  Thu, Apr 17 2008, 14:58 GMT

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