Panel, Conference Presentation
Trends Shaping Global Credit Markets
Milken InstituteTracy Alloway, Sir Michael Hintze, Paul Horvath, Steven Shapiro, David Warren, Michael Hintze
- Credit spreads in the high-yield market could yield mid to high single-digit gains if they tighten further, but may also widen significantly to cause losses between 18% and 30% depending on the scenario.
- Credit conditions are expected to tighten soon, likely triggering a recession in developed markets such as the U.S., driven by a normal business cycle where the Federal Reserve raises rates in 2018, 2019, or 2020.
- Corporate earnings deductibility may decline for certain high-yield issuers over the next couple of years, forcing non-taxpayers to become taxpayers and creating distinct winners and losers.
- CCC-rated credits are projected to underperform over the next 12 months due to tight spreads and issuance representing 15% of the market.
- A significant distressed investment opportunity is anticipated within the next 12 to 24 months as debt investors fail to price current market risks appropriately.
- A long-short credit strategy may become viable in the coming period due to increasing dispersion that allows short positions to function effectively.
- Companies possessing pricing power will likely outperform those without it as rates rise, creating performance divergence even within a growing economy.
- Deal pullbacks will likely continue as financing costs increase from 8% or 8.5% to 10% or higher, signaling healthy market adjustments.
- Market liquidity is expected to originate from demographic shifts in Japan and the U.S., specifically from pensioners and high-net-worth individuals, offsetting concerns about dealer balance sheet shrinkage.
- Structural changes involving passive money, algorithmic trading, and shorter holding periods will likely drive increased volatility, benefiting investors who utilize fundamental analysis.
- Free cash flow metrics will continue to support corporate credit as long as the ratio to interest expense remains near all-time highs, though liquidity issues are forecast to become the primary driver of defaults if rates rise significantly.
- Interest rates reaching 7%, 8%, 9%, or 10% would likely cause major problems for most companies, whereas levels of 4% or 5% may not tip the balance into negative performance.
- Recovery rates for senior secured bank debt in the next restructuring cycle are projected to fall to 60 cents on the dollar or lower from the historic 70-cent average, resulting in significantly lower recoveries for subordinated tranches.
- Liquidity mismatches between credit ETFs and their underlying assets are expected to persist, creating pricing inefficiencies and market dislocations for active managers to exploit.
- Emerging markets may offer tremendous value for investors identifying entities benefiting from fiscal stimulus in the U.S. and China, provided they focus on growing sectors and avoid extensive financial engineering.
- Regional debt in countries like Argentina could offer attractive value relative to sovereign debt, as regions sometimes trade wider than the sovereign despite superior credit statistics.
- Equity markets may be pricing in more risk than the debt market for certain distressed names, potentially creating opportunities for equity debt arbitrage in the near future.
- Quantitative tightening is likely to increase the probability of default for triple-C rated credits, rendering this segment riskier than in the quantitative easing era.
- The high-yield market is currently positioned in the mid to late or late cycle, offering mid-cycle compensation for late-cycle risk.
- Stock picking will likely become the primary strategy for generating alpha over broad market timing due to the current credit market environment.
- The golden age for credit investors may be commencing due to Chinese investment via the Belt and Road Initiative, which could inject $10 trillion into the global economy over the next 20 to 30 years.
- Financial conditions are expected to choke off economic growth as wage growth accelerates and the Federal Reserve implements more rate hikes than currently anticipated.