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Moody's Weekly Market Outlook Summary

Core Content

This Moody's Weekly Market Outlook provides a detailed analysis of the current state of credit markets and equity performance, with a focus on the relationship between corporate credit quality and equity markets. It also includes forecasts and economic data for the US, UK/Europe, and Asia-Pacific regions, highlighting key trends in corporate defaults, credit spreads, and macroeconomic indicators.

Main Points

Corporate Credit and Equity Market Relationship

• Lower grade corporate bonds have a close relationship with the equity market. A healthy equity market supports corporate credit quality by increasing the value of business assets and collateral.
• A benign default outlook (expected to remain at 2.3% by year-end 2014) supports equity prices, implying that overvaluation is not as extreme as in the late 1990s.
• The recent high-yield bond spread of 384 bp is considered appropriate given the low average high-yield EDF metric of 2.01%, which has decreased by 25 bp in the last three months.
• A rising equity market does not always equate to a healthy one. The late 1990s saw a disconnect between equity price growth and corporate credit quality, with high-yield default rates rising from 3.0% to 6.2% despite a 53% increase in stock prices.

Credit Market Metrics

• Investment Grade (IG) Bond Issuance:
  • 2013: $1.134 trillion (down -1.5%)
  • 2014: Expected to fall to $1.063 trillion (down -5%)
• High Yield (HY) Bond Issuance:
  • 2013: Reached a record $431 billion (up 11%)
  • 2014: Expected to drop to $388 billion (down -10%)
• Defaults:
  • US HY default rate: 1.8% in January 2014, down from 3.3% in January 2013 and 2.2% in December 2013
  • Forecast to remain at 2.3% by year-end 2014
• Credit Spreads:
  • Investment Grade: Expected to remain close to 102 bp
  • High Yield: Expected to narrow to 375 bp by year-end 2014 from a recent 384 bp

Equity Market Volatility and VIX Index

• The VIX index has shown a strong correlation with high-yield bond spreads (0.91 since 1999), with a lower VIX index indicating a more stable equity market.
• The recent VIX index of 14.1 is consistent with the current high-yield bond spread of 384 bp.
• A low VIX index supports the equity rally by signaling investor confidence and reduced volatility.

Key Economic Forecasts

United States

• Import Price Index – January: Forecast at -1.0%
• Industrial Production & Capacity Utilization – January: Forecast at 0.3% and 79.3% respectively
• Consumer Sentiment – February Preliminary: Forecast at 80.3
• FOMC Meeting Minutes: Expected to discuss QE3 tapering, but may suspend it if higher bond yields threaten economic growth
• Existing Home Sales – January: Forecast at 4.65 million
• Discretionary Retail Sales: Expected to slow from 6.7% in 2013 to 1.4% in 2014 due to weak economic conditions and subdued consumer confidence

Europe

• Euro Zone PMI Composite Output Index – January: 52.9 (highest since mid-2011)
• Germany PMI – January: Rose above the expansion threshold, indicating faster improvement in business conditions
• Spain PMI – January: Reached a 3-year high, signaling a potential recovery in manufacturing
• Italy PMI – January: Remained above the expansion threshold, but economic growth is expected to be weak due to high unemployment and a strong euro
• Euro Zone Balance of Payments – December: Expected to narrow, with a surplus of €20 billion
• Euro Zone External Trade – December: Surplus of €11 billion, driven by strong demand from key trading partners like the UK and US

Asia-Pacific

• China's Economic Recovery: Supported Russian exports of energy and manufacturing
• Russia Foreign Trade – December: Surplus of US$15 billion, driven by high oil prices

Market Data and Publications

• Moody's Analytics provides updates on credit spreads, CDS movers, and issuance
• Recent publications include commentaries on BAC, US alpha, EU alpha, MET, CS, Argentina, yields, and bank risk
• Moody's Credit Outlook is a sister publication that includes rating agency analysis, recent rating changes, and research summaries

Conclusion

The outlook for corporate defaults is benign, supporting equity prices and contributing to a constructive environment for the market. While equity markets are overvalued, improved credit metrics and a stable VIX index help justify current valuations. However, the sustainability of the equity rally depends on continued profit growth and a strong recovery in key economies. Economic data for the coming week will provide further insight into the health of the markets and the direction of credit conditions.