Market Outlook

2020 Midyear Market Outlook: A Focus on Credit Quality

June 19 2020

The economic damage wrought by the coronavirus pushed credit quality into the spotlight in the first half of 2020, as fixed income investors sought shelter in sovereign debt and other top investment‑grade (IG) assets.

While credit spreads have narrowed from the worst of the market sell‑off in March, they remain wide and volatile, Vaselkiv notes.1 However, as in global equity markets, performance has been highly uneven.

In the high yield market, yield spreads for BB rated bonds perceived as defensive have tightened to pre‑crisis levels. Yet, some “fallen angels”—companies that have recently lost their IG ratings—have been forced to sell bonds with yields as high as 9% to shore up their balance sheets. In this environment, investors need to carefully analyze relative value on a case‑by‑case basis, Vaselkiv says.

Opening Quote Right now, corporate credit—both investment grade and high yield—remains our dominant theme. Closing Quote
— Mark Vaselkiv, CIO, Fixed Income

In forecasting potential default rates, T. Rowe Price analysts have divided the high yield universe into three broad groups, Vaselkiv says:

  • Industries like airlines and cruise lines that face existential risks. Some of these issuers are likely to undergo restructuring either inside or outside of bankruptcy. A number of energy companies also may fall into this category if oil prices remain below USD 40 a barrel.
  • Cyclical industries, such as automakers and homebuilders, where revenues and profits have fallen sharply but new bond issues can help companies build bridges to recovery.
  • Sectors that are well‑positioned to benefit from changing consumer behavior. These could include some media companies, quick‑service restaurants, and supermarket chains.

Many fixed income managers already have rotated into well‑positioned sectors and now are cautiously expanding their cyclical exposures, Vaselkiv says. How that latter category fares in the recovery will determine the peak default rate for the high yield universe as a whole. An aggregate rate close to 10% appears warranted, he adds. 

Credit Spreads Have Tightened Since March but Remain Wide and Volatile

(Fig. 3) U.S. High Yield Spread History1

U.S. High Yield Spread History Graph

Past performance is not a reliable indicator of future performance.

January 1, 1997, through May 31, 2020.
Sources: Bloomberg Index Services Limited, and ICE BofAML (see Additional Disclosures). T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved.
1 U.S. High Yield = ICE BofA US High Yield Index. U.S. High Yield Energy = ICE BofA US High Yield Energy Index. A basis point is 0.01 percentage point.

Corporate Credit Remains the Theme

Attractive fixed income opportunities in the second half appear relatively limited, in Vaselkiv’s view. Defensive assets, such as U.S. Treasuries and other developed sovereigns, AAA rated munis, and even some high‑quality securitized sectors, are expensive and vulnerable to a further backup in interest rates if the recovery proves faster than expected and/or a vaccine becomes widely available.

In emerging fixed income markets, some specific opportunities appear attractive, but the sector as a whole remains under severe pressure from the pandemic and, in some countries, such as Brazil, from poor political leadership, Vaselkiv says. Sovereign default rates have risen.

“Right now, corporate credit—both investment grade and high yield—remains our dominant theme,” Vaselkiv concludes.

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Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of June 2020 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

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Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Investing in technology stocks entails specific risks, including the potential for wide variations in performance and usually wide price swings, up and down. Technology companies can be affected by, among other things, intense competition, government regulation, earnings disappointments, dependency on patent protection and rapid obsolescence of products and services due to technological innovations or changing consumer preferences. Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. All charts and tables are shown for illustrative purposes only.

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