The Roundup: Top Takeaways from Oaktree’s Quarterly Letters - December 2023 Edition

Summary

• Credit markets experienced dramatic swings in investor sentiment, unexpected geopolitical events, and the second consecutive year of rising interest rates in 2023.
• Inflation surged well above the 2% target in 2021 and 2022, leading the Federal Reserve to aggressively hike interest rates after initially labeling the spike as transitory.
• Interest rates are expected to remain lower than current levels but not return to near-zero rates, as consistent sub-2% inflation seems unlikely due to slowing globalization and rising union influence.
• The U.S. economy may slow in the coming year due to fed funds rates above 5%, dwindling excess savings, and inflation exceeding the Fed's target.
• Default rates for liquid credit are unlikely to reach double-digit levels seen in previous recessions because defaults during the pandemic were pulled forward.
• The leveraged loan market is expected to record a higher default rate than the high yield bond market, with recovery values likely below the long-term historical average of 65%.
• The total dollar amount of defaulted debt may be higher than in previous recessions because the global supply of potential distressed debt has more than quadrupled since the Global Financial Crisis.
• CLO equity generates immediate cash and provides quarterly distributions, contrasting with private equity instruments that typically require 5-7 years for distributions.
• Default rates in the leveraged loan market could reach 4% in the U.S. and Europe in 2024, meaning 96% of all leveraged loans would still be performing.
• High yield bond investors can earn yields above 8.0% with solid credit fundamentals, as the average yield on B-rated bonds rose from 4.7% at the end of 2021 to 8.7% as of November 30, 2023.
• The average debt-to-EBITDA ratio in high yield bonds remains at 4.0x, which is below the long-term historical average, while the average interest coverage ratio is elevated at around 5.0x.
• Secured bonds represented almost two-thirds of 2023 U.S. high yield bond new issuance, providing more downside protection in the event of a restructuring.
• Over $500 billion of real estate debt is due to mature between 2023 and 2025 across the UK, France, and Germany, creating a refinancing need.
• The all-in cost of debt for European real estate has more than doubled from roughly 3.0% in 2019 to around 7.5% currently.
• A debt funding gap of approximately $155 billion is estimated between 2023 and 2025 in the UK, France, and Germany due to lenders willing to lend at only 35% of 2019 acquisition valuations.
• Biotech stocks have experienced their third consecutive year of negative performance, with the S&P Biotechnology Select Industry Index down 55% from its February 2021 peak.
• Over 230 stocks in the S&P Biotechnology Select Industry Index are trading at levels that leave issuers with negative enterprise values.
• Healthcare M&A deal volume rose to roughly $180 billion in 2023, with nine of the last ten major transactions pursued by multiple parties.
• Net outflows from EM-dedicated retail funds since the beginning of 2022 have eclipsed $55 billion, while crossover investors have increasingly abandoned EM debt for developed market opportunities.