Corporate Credit Outlook 2020 – The Big Squeeze

Key Takeaways

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Credit – Supported by Hunt for Yield and Strong Technicals in 2020

  • We foresee a marginal improvement in corporate fundamentals in an ongoing environment of low interest rates
  • Credit spreads may have room to tighten further, supported by a strong technical backdrop
  • We see opportunities in EM hard currency corporates in short and regular duration bonds, US investment grade BBB rated credits and bonds at the long end of the curve due to possible flattening
  • We maintain a constructive view of financials, particularly within Europe, and of corporate hybrids where we are selective due to rich valuations
  • The performance of US and European loans lagged in 2019 and we believe offer some relative value opportunities in 2020
  • The outperformance in BB rated bonds has created more dispersion in credit markets, which active credit specialist portfolio managers may want to exploit by moving slightly lower down the credit spectrum

Macroeconomic Environment – The corporate credit outlook for 2020 is very dependent on the macroeconomic scenario,  in our view:

  • Global Economy – Fragile but with potential for recovery if trade tensions abate
  • Geopolitical Risk – Always some uncertainty
  • Monetary Policy – US has greater capacity for rate cuts than other central banks, if needed
  • Environmental, Social and Governance (ESG) Factors – Increasing awareness and implementation
  • China – Focus on economic health remains prominent
  • Macroeconomic Feedthrough into Credit – Maintain a quality bias until macroeconomic recovery firms

Fundamentals – Signs of Improvement Ahead

  • We see more encouraging signs for fundamentals in 2020 and believe corporates are likely to focus on deleveraging
  • From a regional standpoint, we believe there is an argument to overweight US and EM corporate credit

Valuations – Tight, But Room for More?

  • Given the macroeconomic cycle is still below its potential output level, we believe investors should avoid the lowest-quality credits, i.e. those with the weakest balance sheets
  • The lack of significant compression between A and BBB rated bonds in the US market suggests there is a potential for relative spread compression in investment grade. Also opportunities in higher quality Bs versus BBs in Europe
  • We believe the relative value argument may be more balanced in favour of loans over high yield bonds in 2020, as there is less to gain from long duration positioning and more focus on carry going forward

Technicals – Underpinned by Strong Demand and Limited Supply

  • We see persistent demand for positive-yielding credit
  • In our view, the long end of the US investment grade credit market should benefit from non-domestic investor demand
  • The supply situation may become more positive for investors; it could decline in 2020 in the US due to deleveraging within the investment grade market, while the high yield market could see more balanced supply/demand
  • We also believe the reverse yankee phenomenon in European investment grade (where US companies issue on the European bond market) is likely to persist and the European Central Bank’s quantitative easing programme should absorb some of the extra supply

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