Why Now is a Great Time to Invest in Convertible Bonds
1- The US activity is not about to step lower
The 20% fall in oil prices over the past 3 months and the 50bp YTD drop in US mortgage rates both have a significant positive impact on spending.
2- A strong dollar is supportive to growth
It should help global exports and consumer purchasing power.
3- European margins have scope to expand
The currency is weakening and monetary policy is becoming increasingly stimulative.
4- The US earnings season has started well
The first few current Q3 2014 releases (Alcoa, Citigroup, Pepsico and Infosys) all were actually decent.
5- The cyclical sectors valuations are very attractive
They represent 2/3rds of the global convertible universe and trade at a 12M forward PE discount of 20% against the defensives, compared to an average discount of 3% in the last 10 years (Source Morgan Stanley).
6- The underlying credit fundamentals are not worrying
The default rates remain very low, leverage is rising but remains low and profit margins are still very high.
7- The convertible asset class is now discounted by 1%
From a valuation standpoint, we believe there is now a market entry level on the asset class, as there is now a majority of fair valued and discounted convertibles in the Investment Grade space and balanced names.
8- Convertible bonds are back in positive yield to maturity
This cheapening has contributed to increase the yield to maturity (MCBE : +0.4%, MCBG +0.8%), which increases even more the average convexity expected over 1 year.