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Market Events

Four Stages of a Credit Crisis and Where We are Now

Mark J. Vaselkiv, Chief Investment Officer, Fixed Income

Q: What Stage of This Crisis Are Fixed Income Markets in Currently?

My lens here: I use four different phase/stages of a crisis.

First is evaluating the positioning of portfolios based on unanticipated developments in the economy and markets. Clearly, no one saw coronavirus coming.

Phase two is raising cash to meet redemptions on the behalf of our clients, many times driven by their own asset allocation decisions as they rotate potentially from fixed income back to equities. Let’s not forget that fixed income over the last two months, the higher quality sectors have performed well in generating positive returns so that they operated as very effective hedges relative to the drawdown in equities. We’re currently working through that.

I believe phase three, stage three, is the most important. And that’s when portfolio managers engage in targeted risk taking and look at compelling valuations in the credit markets, in securitized structures to generate over time over time higher total returns to offset some of the losses that we’ve experienced over the last month.

Phase four is preparing for the ultimate whiplash when the markets snap back and tighten spreads very suddenly. It’s very difficult, I would say virtually impossible, to pick the bottom. I’ve been through this four or five times in my 30 years in the high yield market. Nobody can predict that bottom, but when the markets do begin to come around, that can happen violently and quickly. If you haven’t engaged in phase three, in the acquisition of good collateral in your portfolios, typically you will lag significantly on the upside.

The balance of protecting on the downside but also participating opportunistically in improving credit situations requires some courage. Right now, given the violence and the velocity of this correction it’s time to engage in phase three.

Q: How are our portfolio managers engaging in this phase?

Energy is certainly front and center facing existential issues today. Two black swans – one, the virus and certainly the developments with OPEC when Saudis decided to flood the market with cheap oil. That will absolutely result ultimately in restructurings in high yield companies. But we’ll also see a number of investment-grade, well capitalized businesses downgraded into the high yield market. We refer to these as fallen angels, and we already have on the list five or six major corporations that will probably come into the high yield market

Last Friday, we organized a collaborative investment meeting with our high yield analysts, portfolio managers, equity analysts, as well as investment grade analysts, to look at a number of these situations. it’s very helpful in these situations because T. Rowe often owns equity positions in these companies as well as credit exposure in our fixed income portfolios. It was a very dynamic meeting on Friday that resulted in a number of some significant buy recommendations.

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This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

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