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The Last Place You'd Think to Hide in a Meltdown

Shuli Ren

(Bloomberg Opinion) -- As if markets didn’t have enough trouble. With the coronavirus outbreak intensifying, and the first shots of an oil price war fired, investors seem to be left with few good options. Could there be anywhere to hide in the world of corporate credit?China, despite two years of record defaults, may be in better shape to withstand an oil slump than the U.S. For now, traders in Asia can sit tight and watch how hard the mighty angels on the other side of the Pacific fall.

Oil’s tailspin is bringing back harsh memories of early 2016, when West Texas Intermediate crude tumbled below $30 a barrel, well beneath the breakeven point for many American producers. U.S. junk bonds’ credit spread over Treasuries shot as high as 8.4%, almost doubling the five-year average. 

The price of oil remains a major catalyst there. When WTI falls below $50 a barrel, the correlation coefficient between that level and the spread of junk bonds more than doubles to 73%, recent sensitivity analysis conducted by HSBC Holdings Plc shows. Energy, metals and mining companies represent about 15% of the high-yield cash bond market.

To make matters worse, a new host of fallen angels — investment-grade firms that get downgraded to junk — may make the high-yield bond universe a bit too crowded. The energy sector comprises roughly a quarter of the $846 billion BBB rated corporate issues in the U.S. When market sentiment is already weak, the last thing traders need is a flood of new supply. 

Asia paints a different picture. Whereas U.S. junk bonds are dominated by companies that profit from “drill, baby, drill,” Asia is all about build, baby, build. 

Just look at who dominates issuance. Even in the throes of the coronavirus outbreak, Asia’s dollar bond market didn’t freeze up, with more than $34 billion of deals in February, up a third from a year earlier. Mainland companies continued to dominate — as they have in recent years — with 65% of the total. Chinese real-estate developers raised a whopping $6.4 billion. Energy companies, by comparison, barely registered. No surprise there: Most Asian countries are net importers.

In Asia, what really matters is Beijing’s liquidity stance — and there are signs that the coronavirus is ending China’s corporate deleveraging campaign, which began in late 2017. From benchmark rate cuts to re-lending facilities for small businesses, officials are tweaking all sorts of rules to ensure that China Inc. doesn’t face a liquidity crisis.

With many sales offices still closed, China’s highly leveraged developers are by all means distressed. But are they any worse off now than, say, in late 2018, when industry titans were wondering if they’d survive a harsh winter? At that point, Beijing had shut down the shadow financing channels that developers relied heavily upon for refinancing.

This month, however, Beijing substantially lowered the hurdle for onshore bond issuers, lifting restrictions that prevented companies with a ratio of outstanding bonds-to-equity of more than 40% from raising money. This directly benefits real-estate developers, which have better ratings onshore, thanks to their land banks.

In the past, if the U.S. sneezed, Asia would catch a bad flu. With China’s rise, markets in the region are slowly evolving. Federal Reserve rate cuts now matter less than Beijing’s liquidity stance. For once, Asia may just provide some diversification benefits.

To contact the author of this story: Shuli Ren at sren38@bloomberg.net

To contact the editor responsible for this story: Rachel Rosenthal at rrosenthal21@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

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