Performing Credit Quarterly 1Q2024: Unusually Uncertain

Summary

• Howard Marks notes that market participants express unusual uncertainty regarding the economy, central bank behavior, fiscal management, politics, and geopolitics.
• A market rally that began five months ago stalled due to stickier-than-expected inflation and expectations of two or fewer interest rate cuts in 2024 instead of the six previously priced in.
• Equity and leveraged credit markets remain robust with high yield bond spreads near the low end of their normal range, over 35% of U.S. leveraged loans trading above par, and the S&P 500 Index up over 20% in the last 12 months.
• Supportive technical factors, specifically high global liquidity, drove recent price increases while countervailing headwinds emerge from cracks in the balance sheets of overleveraged borrowers & overextended consumers.
• Bank reserves have increased slightly despite quantitative tightening because reverse repo balances have declined, leading banks to ramp up lending activity.
• The U.S. high yield bond market saw inflows of nearly $20 billion through March 31, 2024, while the market shrank by roughly $240 billion or over 15% in 2022-2023.
• Net issuance in the high yield bond market reached only $15 billion in the first quarter, well below the $300 billion seen in the investment grade bond market.
• New issues in the high yield bond market were four to seven times oversubscribed in January due to demand outpacing supply.
• Demand in the U.S. leveraged loan market surged due to the creation of over $45 billion in new collateralized loan obligations in 2024, a 40% increase over the same period in 2023.
• The U.S. syndicated loan market shrank by approximately $9 billion in the first quarter & is nearly $30 billion smaller than its September 2022 peak.
• Distressed debt trading below 90 cents on the dollar with yields above 15% grew from $30 billion across 40 issuers at year-end 2021 to over $150 billion across almost 200 issuers at present.
• Altice France announced creditor haircuts, causing its credit rating to be cut to CCC by S&P Global Ratings & Moody's, which triggered volatility in European loan & high yield bond markets.
• Consumer loan losses have soared in the non-prime segment for loans originated in 2021 & 2022 because underwriting models were trained on pandemic-era performance data.
• Demand for junior tranches in asset-backed securities has essentially dried up while investors remain comfortable buying investment grade tranches.
• The yield of the U.S. high yield bond index is near 8%, which is almost 1.5 times the ten-year average & the index trades below both par & the decade-average price.
• Credit spreads in the high yield bond market are near 330 basis points, similar to the level in the first quarter of 2018, while the percentage of BB-rated issuers remains near a decade-high of 48%.
• The equity risk premium is the lowest it has been since 2001, making leveraged credit appear more attractive relative to equities.
• Investors in high-quality non-investment grade portfolios can currently earn roughly 8% yields while waiting for market dislocations.
• The report suggests downside shocks remain more likely than upside surprises if the Federal Reserve's dovish pivot continues to disappoint.