US credit offers better short-term value than Europe

The US credit market looks a safer bet than its European equivalent, according to independent research firm CreditSights.

In a report entitled ‘Seeking relative value between Euro and USD credit’, CreditSights predicts default rates in Europe will rise still further, and the time lag in the economic cycle makes the region a less secure prospect for investment than the US.

“Historically the US tends to lead Europe by six to 12 months in terms of the economic cycle,” says Simon Ballard, a senior credit analyst at CreditSights. “I think in that respect, it will recover ahead of the pack. That’s why you want to be focused more on US credit in the short term as opposed to European credit, which remains volatile.”

Moody’s Investors Service forecasts that the speculative grade default rate for Europe will peak at 10.9% at the end of this year, before falling to 6.0% by September 2010. In contrast, Moody’s predicts that the US speculative grade default rate will have fallen to 4.4% by September 2010.

Ballard says the Federal Reserve’s more aggressive stance in maintaining interest rates at 0.25% since December last year will help the US see economic growth and improved corporate credit quality before Europe. “The Fed, whatever Gordon Brown might try and tell you, was unarguably ahead of the curve in addressing the economic crisis,” he says.

Despite his optimism regarding US credit, Ballard thinks that a defensive strategy is still best for investors. “We believe the momentum behind the recovery story has overplayed itself, so we want to be in the less cyclical sectors that will be able to weather perhaps that second downdraft of the W-shaped recovery,” Ballard says. In terms of sectors offering stable cashflows, Ballard favours utilities, metals and mining, healthcare and pharmaceuticals.

Not all forecasters feel a solely non-cyclical strategy is necessary though. “The economic environment is certainly more benign than it was six months ago,” says Vasant Mehta, a credit analyst specialising in bonds at Payden & Rygel. “You can still get good spreads on some cyclical credits. These are companies that do not need double-digit top-line growth in order to survive and generate cash, even in an anaemic economic growth scenario.”

Both analysts agree, however, on the continued need for caution. “We want to avoid credits that are dependent on a very optimistic blue-sky economic scenario, as risks to the economic recovery remain,” says Mehta.

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