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North America Credit Research

02 May 2019

Credit Market Outlook &

Strategy

US High Grade Strategy & CDS Research

US High Grade Strategy & Credit

Derivatives Research

Eric Beinstein

(1-212) 834-4211

[email protected]

Paul Glezer

(1-212) 270-8185

[email protected]

Pavan D Talreja

(1-212) 834-2051

[email protected]

Sheila Xie

(1-212) 834-3036

[email protected]

J.P. Morgan Securities LLC

See page 32 for analyst

certification and important disclosures.

J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aw

are that the

firm may have a conflict of interest that could affect the objectivity of thi

s report. Investors should consider this report as only a single factor in

making their investment decision.

www.jpmorganmarkets.com

High Grade Strategy

High Grade bond spreads rallied 12bp in the first half of April to 139bp and

remained there for the past two weeks. Last month was positive news on US

growth as GDP came in at 3.2% compared with much weaker estimates earlier in

the quarter. Corporate earnings also have come in better than expected (though

not strong) with EPS growth of 0.5% y/y on the quarter so far, compared

with -2.0% expected at the start of earnings season in early April. Supply was in

line with expectations at $92bn last month and is down 6% y/y. This has brought

net supply down by 18% y/y. The slowdown in supply has been driven by

Financials, and they have outperformed Financials partly on the back of this. The

cost of FX hedges for Euro and Yen-based investors has risen recently, but not for

Taiwan based investors. Based on TRACE data overseas demand for USD credit

is running near the 2018 level, following a strong Jan-Feb. The 20s30s spread

curve suggests that 20yr bonds remain cheap – despite the message given by

analyzing 20s30s benchmark curves.

Credit Derivatives

CDX HY has outperformed most credit and equity indices since its roll last month.

CDX.HY index is trading rich versus HY bonds, iTraxx Crossover and the Russell

2000. However, CDX.IG and CDX.HY are trading in line. Trading activity has

picked up significantly in the CDX.IG 3y and 10y indices. CDX.IG 10y index is

one of the three most traded linear instruments in HG credit after CDX.IG 5y

index and LQD. The CDX.IG S31 senior mezzanine tranche has underperformed

while the junior mezzanine tranche has outperformed in the recent rally. This

provides attractive relative value opportunities to position for a mild index selloff.

Additionally, the CDX.IG senior mezzanine tranche appears as a more attractive

long than the CDX.IG index. We discuss an option trade to position for CDX

indices trading range bound over the coming weeks without taking risk in a large

selloff.

Trade Tracker

Since our last publication, our Trade Tracker is up $7,715. Over the last twelve

months, performance is up by $720,174 (+4.3% ROI / +19.8% IRR).

Chart of the week: HG bond spreads rallied 12bp earlier last month and remained flat since then

Source: J.P. Morgan

100

120

140

160

180

200

Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19

JULI Spread

North America

Credit Research

02 May 2019

Eric Beinstein

(1-212) 834-4211

[email protected]

Summary and Outlook

High Grade bond spreads rallied 12bp in the first half of April to 139bp and

remained there for the past two weeks. Over the month HG bond yields were down

by 3bp to end the month at 4.01%. In April there was positive news on US growth as

GDP came in at 3.2% compared with much weaker estimates earlier in the quarter.

Corporate earnings also have come in strong with EPS growth of 0.5% on the quarter

so far, compared with -2.0% expected at the start of earnings season in early April.

Supply was in line with expectations at $92bn last month and is down 6% y/y. This

has brought net supply down by 18% y/y. The slowdown in supply has been driven

by Financials, and they have outperformed Financials partly on the back of this.

Exhibit 1: HG bond spreads rallied 12bp earlier last month and have been flat since then

Source: J.P. Morgan

Earnings 2/3 of the way through the reporting season are

not strong but are beating low expectations

EPS results in 1Q have strongly surpassed expectations and revenue results have

beaten too, but to a much less extent. With 364 of 499 S&P500 companies having

reported, 76% have surpassed expectations for EPS growth and 56% have done so

for revenue. The actual EPS outcome is running at a rate of 0.5% increase in 1Q19

vs 1Q18 and revenue growth is coming in at 5.0% over last year. Over these 4

quarters US nominal GDP growth increased by 5.1%. There has been a headwind

with oil prices averaging $63.66/bbl in 1Q19 vs $67.20/bbl in 1Q18, a 5% decline.

Overall, US companies have grown EPS significantly slower than nominal GDP

growth, but just not as much behind as analyst had estimated going into the quarter.

For Revenue the y/y growth stands at 5.0%, which matches nominal GDP.

Exhibit 2: US Nominal GDP growth in 2019 is expected to slow

Source: J.P. Morgan

100

120

140

160

180

200

Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19

JULI Spread

4.6

5.4

5.5

5.2

5.1

4.4

4.2 4.2

0.0

1.0

2.0

3.0

4.0

5.0

6.0

1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19

Nominal GDP (% change over year ago)

North America

Credit Research

02 May 2019

Eric Beinstein

(1-212) 834-4211

[email protected]

1Q'19 was another solid quarter for the US bank sector, as the majority of companies

reported results that came in ahead of estimates. On the positive side, revenue was

higher both QoQ and YoY, net interest income was higher YoY, and capital and

credit quality both showed little signs of deterioration. However, the 1% YoY

increase in net revenues was below the 4 – 6% YoY growth reported during the four

quarters of 2018, net interest income and margins declined QoQ, and trading

revenues remain pressured. Higher net interest income has driven top-line growth for

U.S. banks during the current rate-hiking cycle, but may no longer be a tailwind for

the sector if rates remain low and the curve remains flat. That said, concerns about

the macro environment were alleviated as management teams repeatedly reiterated

that they are not seeing signs of economic slowdown. See Kabir Caprihan’s

Quarterly Checkbook report for more details (link).

Exhibit

Revenue growth for S&P500 companies is expected to be

modest in 2019

Exhibit

EPS

growth for S&P500 companies is expected to

stay low

for most of 2019

Source: J.P. Morgan, I/BES data from Thomson Reuters Refinitiv

May has been the most active supply month of the year. We

estimate about $70bn M&A funding in the remainder of 2Q

The market is focused on May supply, and this is logical as May is historically the

most active supply month of the year. Over the past four years May supply has

averaged $147bn, and spreads have widened by 5bp on the month. This compares to

average monthly supply across all months of $99bn and spread being unchanged on

average over the same four year time period.

Exhibit

: The 4yr monthly average issuance peaks in May at $147bn

Exhibit

HG bond spreads have widened by 5bp in May on

average

Source: J.P. Morgan, Dealogic

7.3%

5.0%

5.5%

8.3%

8.4%

9.5%

8.6%

5.1%

5.0%

4.1%

4.5%

5.9%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19

S&P 500 Sales Y/Y Growth

Estimates

15.3%

12.3%

8.5%

14.8%

26.6%

24.9%

28.4%

16.9%

0.5%

1.6%

1.9%

8.4%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19

S&P 500 Earnings Y/Y Growth

Estimates

123

120

147

118

106

100

114

100

120

140

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

4yr Avg Gross Issuance (2015-2018)

2019 Gross Issuance

$bn

-7

-6

-2

-5

-21

-5

-2

-12

-25

-20

-15

-10

-5

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

4yr Avg JULI Spread M/M ∆

2019 JULI Spread M/M ∆

North America

Credit Research

02 May 2019

Eric Beinstein

(1-212) 834-4211

[email protected]

There has been $412bn of HG corporate bonds issued YTD. This is down 6% y/y

from $436bn in YTD 2018. M&A-related issuance is $45bn YTD, which is 11% of

gross supply. Last year at this time $74bn of M&A funding had already been issued,

including $40bn from the CVS-Aetna deal, so the y/y decline in overall issuance can

be attributed to less M&A funding in 2019.

We estimate a current backlog of $116bn of M&A funding for deals already

announced but which have not yet issued their bonds. Of this, we estimate that $68bn

will come in the remainder of 2Q. If this proves correct that would leave $48bn to

come in 2H19 from deals we currently know of. If several of the large deals expected

to fund in 2Q come in May then it would not be difficult to see supply this month

approach the 4yr May average supply of $147bn.

Our full year M&A supply forecast is $200bn. The sum of what has already been

issued plus the estimate from announced deals is $161bn. This leaves just $39bn to

reach our forecast, and there are seven months to go, so this seems achievable.

However, there are often two or three quarters between deal announcement and

funding, so we are not uncomfortable with $200bn full year estimate at this point.

Exhibit 7: YTD M&A-related supply is $45bn. We estimate $116bn of funding for announced but

pending deals to come in the remainder of 2019

Source: J.P. Morgan

For Financials the pace of issuance in 2019 has been well below recent run-rate

levels. YTD USD supply is at $149bn, 35% of our FY forecast. Supply consists of

$63.6bn of debt from US banks (39% of our 2019 forecast), $49.5bn from Yankee

banks (26% of forecast) and $12.4bn from finance companies (39% of forecast). For

comparative purposes, YTD USD issuance for Financials was at $193bn on May 1,

2018 and $200bn in 2017. The current year measured pace of issuance points to

funding needs that are more manageable going forward.

Overall we remain comfortable with our full year 2019 issuance forecast of $1.05tr.

This is down 7% from $1.13tr in 2018. YTD we are down 6% so on track to this

outcome. Lower yields and lower spreads do argue for some upside risk to the supply

forecast, but Financial supply is running about 25% below last year at this time, so

this may provide some offset.

275

221

143

223

116

100

150

200

250

300

350

2015 2016 2017 2018 2019

Remaining M&A to Forecast

Announced but Pending M&A related issuance

Actual M&A related issuance

19%

$bn

23%

11%

20%

19%

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