If you ask Jeff Gundlach (which nobody did, but he weighed in anyway), unidentified “people” are “amazingly copacetic about the credit situation.”
As noted earlier this week, it’s not clear who those “copacetic” “people” are because the financial media is anything but sanguine about the readily apparent cracks showing up in credit and when it comes to markets themselves, I’m not sure the biggest weekly blowout in investment grade spreads (last week) since 2016 counts as “copacetic”.
In high yield, I am absolutely positive that “copacetic” isn’t the right adjective for what you see unfolding on the right-hand side of both the top and bottom pane of the following visual.
In any event, Gundlach’s assessment of unnamed people’s imaginary obliviousness aside, market participants and various pundits are clearly concerned about credit and that concern is showing up in the year-ahead credit outlook pieces from Wall Street.
For their part, Goldman was out this week with an amusingly straightforward/deadpan take on things which finds the bank listing the three key factors behind recent turmoil in non-“copacetic” credit markets where “the tide appears to have shifted, with spreads breaking out of the range of the last two years.”
After stating the obvious, which is that things started to go awry in earnest midway through last month, Goldman lays out the issues as follows:
- First, what began as a sharp repricing of idiosyncratic risk in the IG market has quickly morphed into heavy selling pressure.
- Second, concerns over the prospect of slower growth, rising inflation, and a higher bar for a change in the Fed’s reaction function have reduced the friendliness of the macro environment.
- Third, the return of “cash” as an investable asset class has undermined the value proposition of corporate bonds, eased the “urgency” of buying the dip, and thus slowed the speed of mean-reversion for spreads.
That’s a pretty noxious mix, and what you should note about point number 2 there is that the read-through for margins at a time when the U.S. corporate sector is leveraged to the hilt is not great. Goldman of course recognizes this. “Increased focus on late-cycle headwinds for profit margins will likely keep idiosyncratic risk elevated”, the bank says, adding that “on the macro front, the environment envisioned by our economists for 2019 is not particularly friendly for risk appetite”.
As a reminder, margins are typically revised lower in Q3, but this year, that trend appears to have accelerated, even as top line growth forecasts actually ticked higher following earnings season.
So, where does Goldman see credit going from here? Well, here are their forecasts, for whatever this is worth.
You can draw your own conclusions there and while I’m not even going to attempt to do some kind of historical study to back up this contention, what I would gently suggest is that it’s hard to imagine how USD IG spread widening will only total 17bps (maximum) in 2019 in an environment where 3M LIBOR moves up to 3.55 over the same period, thus dragging up returns on the very same “cash” that Goldman has variously flagged as a newly-viable alternative to risk assets.