Count me incredulous when it comes to the idea that credit spreads can tighten materially from current levels.
The spread compression we’ve seen in IG and HY over the past 12 months has been nothing short of remarkable and is, I think, entirely out of step with fundamentals.
Given where we are in the credit cycle (of course that’s always a bit of a subjective assessment) and given leverage and the general richness to fair value, I have serious concerns about stepping into this market.
(Charts: Morgan Stanley)
Credit does have the inflation argument going for it (i.e. higher inflation expectations equals tighter spreads historically speaking), but that’s not enough to dispel my concerns.
In any event, I stumbled across some commentary out this weekend from Barclays and although I’m just going to present a very short excerpt, note the overarching point: with spreads having come in as much as they have, there’s not much left for average investors. At this point you’re talking about stepping into individual credits to take advantage of idiosyncratic moves and that, I’d wager, isn’t something that Joe ETF is cut out for.
The rally in credit markets since the election has taken cash spreads in both investment grade and high yield to the tightest levels since late 2014/early 2015 (Figure 2). As a result, we believe that investors need to continue to look for creative ways to generate alpha. Along those lines, this week’s investment grade section examines how unusual volatility in individual credits can be a predictor of further volatility, particularly after large downward moves. We find that multiple weeks of volatility demonstrate an even higher likelihood of big moves down the road. And in the high yield section, we highlight opportunities at the very long end of the curve (10y+), most of which are fallen angels that trade at a decent discount due to rate concerns and the fact that high yield investors are not natural buyers.