Fixed Income

Market Events

Four Stages of a Credit Crisis and Where We are Now

March 20, 2020
We believe we are in the third phase of the current crisis, targeted risk taking, and have identified a number of opportunities based on extensive research.

Key Points

  • The first stage of a credit crisis is evaluating portfolios based on unanticipated developments, while the second stage is selling securities to meet redemptions.
  • Given the velocity of the current correction, it’s time to engage in phase three, targeted risk taking, in anticipation of the fourth phase, market recovery.
  • We have identified a number of opportunities for risk taking, including well-capitalized businesses that could potentially be downgraded into the high-yield market.

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.

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 March 2020 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

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.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

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. All charts and tables are shown for illustrative purposes only.

This material has been prepared by T. Rowe Price for general and educational purposes only. This material does not provide fiduciary recommendations concerning investments, nor is it intended to serve as the primary basis for investment decision-making. T. Rowe Price, its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this material.


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