In addition, government and central bank support—such as low-interest-rate policies and securities purchase programs—has aided market liquidity and financing for businesses during the crisis. We expect rates to remain low well into the future and many support programs, including fiscal stimulus, to be extended through the recovery. This should provide continued backing for credit markets.
Attractive Valuations Can Be Found, but Be Selective
In developed markets, corporate credit spreads have already recovered materially, and now sit marginally above pre-COVID-19 levels. That might seem surprising at this stage in the recovery. But because credit migration and defaults have led to higher quality indices, historical comparisons are less reliable. In fact, after adjusting for quality, credit is priced at more compelling spreads today than at this point in a traditional recovery cycle.
The key is to be selective. Spread dispersion across and within sectors will remain significant. But it will take deep fundamental analysis to identify opportunities successfully and to sift winners from losers.
For instance, companies running with higher leverage and exposed business models, such as car rentals, will likely continue to struggle. On the other hand, select travel and cyclical credits trading at attractive premiums may offer better opportunities. We look for companies with stronger balance sheets, more durable businesses, disciplined financial policies, and demonstrable access to capital markets, both in the form of equity injections and debt issuance.
Lastly, environmental, social and governance (ESG) factors are becoming increasingly important to both investors and the companies they invest in. Companies with high ESG scores are more highly valued, and those with poor ESG scores are having increasing difficulty refinancing debt. This trend has accelerated in 2020, and we expect it to become more pronounced in the coming months and years.
Credit Opportunities Across Regions
Global credit investors can find opportunities across regions because of disparities in yield and differing exposure to economic recovery.
For example, among investment-grade credits, pockets of emerging-market corporates offer attractive yield advantages over euro-area and US markets. Emerging markets are also poised to get a bigger lift from the arrival of vaccines and a possible early recovery.
Regional differences are also apparent in the extent of support from central banks. So when considering opportunities, investors need to balance the potential benefits of economic recovery against the powerful advantage of central bank purchase programs.
Across high-yield markets, US credits may benefit from a bigger economic rebound, but euro-area high yield enjoys a robust level of support from the European Central Bank (ECB), as well as a higher aggregate credit quality and lower exposure to the volatile energy sector.
Currently, within US investment-grade, we continue to see value in select BBB-rated credits. In euro high yield, we think BB-rated debt and some banks’ Additional Tier 1 (AT1) subordinated bonds look compelling. For the larger US high-yield market, we see opportunity in select B and CCC names.
Emerging-market high-yield corporates require caution. Special consideration should be given to companies with high transparency and visibility into future cash flows, in our view. Current valuations in Asian credits look particularly attractive. Here, spreads are currently near their historical highs while underlying credit fundamentals are largely stable.
Watchpoints Unlikely to Mar the Outlook for Credit
The path ahead may contain surprises and challenges, but we see plenty of opportunity in credit markets in view of continuing easy monetary policy, committed fiscal stimulus and improving levels of economic activity.
We believe that active multi-sector approaches provide the best risk-adjusted potential returns, especially during times of heightened uncertainty. Such strategies can pair interest-rate risk with more diverse sources of credit risk—including securitized and emerging-market debt—as well as the full range of developed-market corporate credit.
In a world with over US$17 trillion of negative-yielding debt, pockets of the global credit market stand out as a sizeable, investable group of assets offering attractive levels of yield. With fundamentals and valuations supportive, and technicals very favorable, global credit may indeed be in the sweet spot for 2021.
Sources: Bank of America, Bloomberg Barclays, Morgan Stanley, Standard & Poors, AllianceBernstein (AB)