In an uncertain environment, credit selection can be key to distinguish companies that will survive from those who will not.
The credit markets’ upward trajectory continued during July, and at the time of writing, also through August. We expected issuance to pause during the summer period, but instead we have seen record levels particularly in the US High Yield market, where year-to-date we have seen a significant increased compared with the same period last year.
The market has, so far, continued to absorb the new issuance as there is strong appetite for credit, with bond prices being supported by central banks, and investors still believing corporate credit can offer value relative to the low absolute level of sovereign yields. In our view, September will be critical in assessing the market capacity to absorb this flow of new issuance.
Default rates expectations have come down too, as companies are able to come to market to add liquidity and strengthen their balance sheet. We have witnessed a divergence between the US and Europe, as the most affected sector is energy/commodities, which represents a large portion of the US high yield market, which is not the case for the European high yield market.
We believe there is a risk of the economy losing momentum in the next few months so further fiscal support will be needed. Looking at the next round of fiscal measures a different picture emerges on each side of the Atlantic. In the US, the agreement for further fiscal stimulus seems to be halted due to the upcoming US presidential election, with Republicans and Democrats not being able to agree on additional measures. By contrast, in Europe, an agreement was reached in July after intense negotiations on the European Recovery and Resilience Fund.
The Recovery Fund is generally regarded as a milestone achievement in the response to COVID-19 related economic threat, and we believe it indicates confidence in a more resilient Eurozone.
We have seen in the last few weeks high yields and tighter spreads across Investment Grade and High Yield markets and while valuations remain attractive, in our view, the economic outlook remains uncertain. This is not the V-shaped recovery investors had hoped for. Companies will need liquidity to survive the coming months. There seems to be a bifurcation between companies that have the balance sheet strength to survive in this environment and those who have not, in our opinion. We believe this calls for a good assessment of the companies and credit selection will be a key element to distinguish the ‘winners’ from the ‘losers’.
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