Slow and steady: Navigating the later stages of the credit cycle
July 3, 2017
Our outlook at the beginning of 2017 was for economic growth and inflation to move higher, and interest rates in the United States to follow the same path. This outlook was based on our expectation of potential stimuli from Washington, DC, including tax cuts, infrastructure spending, and deregulation. Now that these policies seem to be on hold, we have less conviction that US interest rates will move significantly higher for the rest of the year and believe they could remain relatively range bound. That said, there are still a number of reasons why we believe the credit cycle could extend in the near term — and among those reasons, an accommodative central bank policy coupled with improved fundamentals.
Global central bank influence should continue to provide a supportive backdrop for corporate credit as the European Central Bank (ECB), Bank of Japan (BoJ), and the Bank of England (BOE) continue to assist the global financial markets with their loose monetary policies. This dynamic should also provide an ongoing tailwind for corporate credit until these central banks start to reverse those policies.
Fundamentals are another encouraging sign that could extend the credit cycle in the near term. For example, we have been seeing a return to revenue and earnings growth for US corporations with the S&P 500® companies now posting three consecutive quarters of earnings growth. This confirms that top- and bottom-line momentum has picked up again as these companies have restored earnings to year-over-year gains.
In addition to earnings growth, we have seen a decrease in default rates in the high yield bond market. This has been the result of a combination of stabilizing commodity prices and access to liquidity from accommodative central bank policy.
Although we still believe the credit cycle could extend in the near term, there are certainly factors in the market that are telling us to proceed with caution. These are specifically valuations, political uncertainty, and commodity prices.
Valuations on both US equities and credit are well through their long-term averages, so if we experience a mean reversion event (an occurrence that would lead asset prices back to their long-term means or averages), it would most likely be to the downside. Political uncertainty continues to cause volatility both in the US and abroad, and this is expected to continue in the near term. Finally, commodity prices, specifically oil, have recently traded lower due to the challenge of balancing supply and demand dynamics. As we move through the rest of the year, we will diligently monitor these areas of caution.
The views expressed represent the Manager's assessment of the market environment as of July 2017, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
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