The Roundup: Top Takeaways from Oaktree’s Quarterly Letters - March 2024 Edition

Summary

• Leveraged credit and equity markets rallied in the fourth quarter and continued through the last three months despite shifting expectations regarding near-term interest rate cuts.
• High yield bond spreads are at their slimmest level in nearly two years, nearly three-quarters of leveraged loans trade at or above 99 cents on the dollar, and new private credit deals offer yield spreads 100-125 basis points lower than 12 months ago.
• Investors believe the U.S. is on a path to a soft landing with declining interest rates, though Oaktree doubts rates will fall as rapidly as anticipated unless a serious recession occurs.
• Oaktree projects the fed funds rate will likely settle between 2-4% over the next two years rather than 0-2%, creating refinancing challenges for leveraged companies with rates above 2%.
• Rescue financings offer strong risk/reward profiles with new debt instruments featuring yields in the mid-teens to low-twenties, superior collateral, and stronger creditor protections compared to existing debt.
• A Bank of America study indicates 30% of 230 private issuers rated B or CCC will have negative free cash flow even if the Fed cuts rates by 250 basis points, while 40% will have negative free cash flow if cuts are only 75 basis points.
• Refinancing risk in U.S. leveraged credit is elevated with maturities totaling $40 billion in 2024, rising to $180 billion in 2025, $365 billion in 2026, and $480 billion in 2027.
• Commercial banks have reduced asset financing activities due to regulations and rising rates, creating opportunities for alternative lenders in the $5 trillion+ asset-backed finance (ABF) market.
• ABF assets provide predictable cash flows, structural protections that redirect payments to senior lenders during asset value declines, and diversification that reduces idiosyncratic risk.
• Real estate transaction volumes fell 52% year-over-year in 2023 after a 13% decline in 2022, but a modest dovish shift by the Fed could increase volumes and price discovery.
• Core and core-plus real estate assets in strong sectors are expected to benefit most from a potential Fed rate cut, while vulnerable segments may remain under stress.
• Global convertibles underperformed global equities by over 12% in 2023, but offer reasonable valuations, average coupons of 2.8%, and premiums 560 basis points below the pre-pandemic average.
• Convertibles issuance reached $79 billion in 2023, double the prior year, with over 25% rated investment grade and issuers with market caps above $10 billion accounting for over 70% of new issuance.
• Chinese equities trade at a record-low 8.2x forward estimated earnings, with the gap between U.S. and Chinese technology stocks at its widest in many years.
• Net cash positions for the top 15 Chinese companies in the MSCI Emerging Markets Index rose from negative $19 billion in 2019 to $113 billion in 2023.