Q&A: where are the risks in credit?

What is your assessment of the macro economic backdrop?

The Global outlook has moved in a stagflationary direction as growth momentum fades and price pressures rise.

I would caution that two important economies, China and the US, are showing signs of slowdown which we think warrants watching more closely.  China in particular is navigating a shift in the priorities of their economy and this is leading to short term uncertainty and increased volatility.

In the US, we have seen job openings accelerating, but employers seem to be having a hard time attracting unemployed people, regardless of the potential slack in the labour market.

Increased concerns about the virus could continue to be a barrier for people to go back to jobs where contact with the consumer is high. Also, a lack of childcare is impacting people’s ability to re-join the workforce, and thus, sustain the wage pressures in the future. We believe this will eventually be solved and on a positive note this could help to extend the credit cycle a bit longer.

The fact that consumers in developed markets continue to be in strong shape as over the last 18 months we saw a surge in savings, is another argument that the credit cycle could be extended.

Credit markets have been supported by monetary policy. Are you starting to see signs of change?

It is clear that the momentum of support from central banks is slowing and in fact you are seeing signs of tightening policy with a number of central banks such as Norway, Turkey and Brazil already hiking rates. It is also getting clearer that the Bank of England is preparing the market for an early interest rate hike.

Central banks remain in a difficult position as they are trying to manage the equilibrium between tighter policy in the face of slowing growth momentum and stubbornly high inflation driven by disruptions in the supply chain.

The People’s Bank of China (PBOC) is the one central bank that has plenty of firepower available, but we think they will remain cautious as they try to navigate away from credit-driven growth which has obviously impacted certain sectors such as real estate significantly.

So on balance, liquidity is declining, but still remains ample, so this leads us to be a little more cautious on certain assets such as US credit which could suffer more on a taper tantrum like scenario.

How are you navigating the current market, with many areas looking quite expensive?

Valuations are looking decidedly unappealing in the investment grade space, so we continue to focus on opportunities in the high yield space.

BB spreads, despite low historical yields, continue to look attractive given improving fundamentals at corporations which should see a relatively benign default picture going forward.

By and large the consumer across many geographies looks very healthy and we are participating in that through residential real estate in Europe, securitised assets in the US and certain idiosyncratic stories such as Saga  (single B, 5.7% yield) which is well positioned to benefit from a recovery in consumer spending.

Finally, after benefitting from a strong rebound in covid recovery and cyclical assets we are starting to move to more defensive sectors such as healthcare and telecommunications. 

Asia is also looking more attractive, but we continue to remain concerned about the rebalancing occurring in China.  The focus on a common property approach links the recent crackdown in the tech, real estate and education sectors and has led to increasing uncertainty within the market. The real estate market has been hard hit, but the continued unknowns around Evergrande make us a little reticent to try and catch a falling knife.  We would also like to see a much broader repricing across a range of sectors as the recent sell off has been very much concentrated in the real estate space.

It does reinforce the need for active security selection as our Asia credit team led by Angus Hui have had a negative view on Evergrande for some time and we had no exposure across the firm.

So in conclusion, we trade carefully, focusing on identifying the pockets of value, balancing cyclical and non-cyclical and areas with further recovery potential.