Panel
Credit Is a Cycle: Finding Opportunity in Turmoil
- The outlook anticipates a recession and a new credit cycle beginning now, with elevated default rates likely over the next couple of years due to corporate re-leveraging and shifting consumer preferences.
- Distressed investing opportunities are expected to arrive in coming quarters, driven by specific risks in bank debt, private credit, rescue financing, and sectors facing secular changes, requiring surgical strategies rather than broad-based approaches.
- Market bifurcation is projected to persist, creating significant dispersion where high-yield investment-grade credits coexist with distressed names, while mid-sized enterprises are becoming "orphaned" offering risk-adjusted returns for nimble managers.
- Specific sector distress is forecast for airlines, with supply chains unlikely to reach 90% of 2019 levels within 24 to 36 months, alongside massive commercial real estate distress in hotels, entertainment, offices, and airlines.
- Residential distress is expected to coincide with high performance due to record equity in U.S. housing, with net returns targeted in the high teens to low 20s, while commercial real estate mid-20s returns are anticipated.
- Portfolio allocations are shifting from investment grade to crossover, high yield, and stressed sectors to compensate for low core fixed income return expectations, with a belief that seven and a quarter percent returns can be achieved over the next 30 years.
- Opportunistic strategies across convertible markets, real estate financing, and distressed debt are expected to generate double-digit returns, with some real estate segments potentially yielding 10 to 20 percent or more depending on risk appetite.
- Uncertainty stemming from the pandemic, unemployment, election outcomes, and stimulus is expected to create volatility and significant price moves, though systemic risk is viewed as lower than in 2008.
- While elevated default rates are predicted, the market may not signal an imminent default cycle unless the U.S. enters a major recession, and high yield credit is considered fairly priced to slightly overvalued given low absolute yields.
- Risks include entering the opportunistic bucket too soon due to an extended cycle driven by Federal Reserve intervention, as well as the possibility that stimulus will fail to resolve confidence issues in specific commercial sectors.
- Post-election stimulus is expected alongside continued Federal Reserve support, potentially accelerating the financial component of recovery, though the current credit market is considered more uncertain than at any time in the last decade.