Talking Credit

Future of credit market

Aug 13, 2018

A conversation about where credit markets are headed with
James Keenan and Tim O’Hara

Q 
How will the credit cycle evolve in the coming 12 months? Should we expect a broad cycle change or smaller industry- or sector-specific cycles?

Keenan: We will generally see stability of global growth in the near term, but a greater probability of weakening and possibly a recession in late 2019 / 2020. The big question is how big a pullback we’ll experience when the U.S. slows. I think a downturn would be relatively small and quick.

I see mini-cycles as more likely than a major 2008-style crisis. We likely won’t face a global liquidity shock, which would be the big risk from a credit perspective. We’d certainly expect the cost of capital to fluctuate, but credit could remain range-bound even through a series of mini-cycles.

O’Hara: I agree. We’re likely to see more sector-specific stress than a bigger, broader downturn. That’s because earnings are strong. The first quarter was one of the best ever for below-investment-grade credits. It’s hard to have a major credit selloff in the short-term when earnings are very strong.

Q

Are there certain sectors that you’re watching right now?


Keenan: There are lots of individual stories at the sector level, many driven by technology. We’ve seen exponential growth of technology and companies disrupting every industry. Retail is an example as we’ve seen online sales grow at the expense and reduction of brick-and-mortar stores everywhere.

Those companies and industries with sustainable demand and on the forefront of technology will likely be winners, including consumer retail.

And generally, one exciting part of the growth of the credit markets is the breadth of companies and subsectors you can invest in. So we can really dig deep into companies or subsectors and focus on those which are differentiating themselves. This is a chance for investors to find good alpha opportunities.

Q
Do you see broad dispersion widening in high yield or a continuation of idiosyncratic dispersion from one-off, single-name events?

O’Hara: It’s likely the dispersion of returns across sectors will increase. Leverage in the overall below-investment-grade markets has decreased over the last couple of years. However, the recent spate of levered acquisition and LBO issuance is occurring at leverage multiples that are at cycle highs, and that trend will likely create more volatility and dispersion.

Q

What keeps you up at night about global credit markets?


Keenan: The two major risks we face are a sharp slowdown in growth or a policy mistake that would accelerate financial tightening. With the shift in debt ownership from households and banks onto central bank balance sheets since the recession, there’s less risk of liquidity shock because that asset/liability match doesn’t exist the way it used to. But it does make growth and sentiment more dependent on policy decisions, including trade, which are getting difficult to predict in today’s climate.

O’Hara: I agree that the biggest risk is a policy-related mistake. For over 30 years the global economy has removed trade barriers. And now we are more interlinked than any time in history, which has been accelerated by technology. It’s very hard to discern what the state of play is at any given moment between the big players. This is less of a worry with monetary policy by central banks because they tend to signal what they’re going to do.

I also worry about which assets become “crowded” in the current market. That is, which assets become too expensive relative to their value, or encourage excess leverage. For example, there’s a lot of talk right now about increasing leverage on below-investment-grade new-issue calendars. However, if you look at North America and Western Europe, the balance sheets getting levered are investment grade, not below-investment-grade. Most high yield companies have used the last couple of years of low rates, and tight credit spreads to refinance and extend their maturities to lower their cost of debt. Casual observers might miss the difference in fundamental credit quality between the different markets.

Download now

James Keenan, CFA
Chief Investment Officer and Global Co-Head of Credit
James E. Keenan, CFA, Managing Director, is Chief Investment Officer and Global Co-Head of Credit within BlackRock Alternative Investors (BAI). He leads the ...
Tim O'Hara
Managing Director
Timothy P. O'Hara, Managing Director, is Global Co-Head of Credit within BlackRock Alternative Investors (BAI). Tim is responsible for the strategic direction ...