Where Might Credit Risks Exist? Follow the Supply
While we are bottom-up investors, we still must recognize the big-picture macro themes or events that may affect our investments. I’d like to outline a few of these themes we see affecting the markets today, including the changing dynamics of the credit market and how technology has brought disruption and potential to various sectors.
As an investor, you have to understand where potential risks exist as well as potential returns. One of the potential risks we see relates to supply. Over the past 10 years, the US investment-grade debt market (corporate bonds), has grown by about $4 trillion.1 This pace of growth has actually outstripped US gross domestic product growth over that period.
Why has this tremendous growth in credit occurred? Look to the central banks.
Since the Global Financial Crisis, global central banks have been providing easy money. Investors have been given incentives to invest in longer maturities and take on more credit risk across the credit spectrum. It makes sense. Why would an investor settle for historically low Treasury yields when there is a plethora of potential corporate bond opportunities that offer a more attractive proposition? However, I think there is a lesson here investors need to heed. To look for potential issues in the fixed income markets, in my view, you have to follow the supply. We have a lot of it right now in the corporate credit markets.
We have seen similar periods of heavy supply that didn’t end well. In the late 1990s, telecom companies were issuing a lot of debt into the marketplace to finance digital-age projects, and many weren’t able to fulfill their promises. Then in 2007, we saw issues surface with non-agency mortgage-backed securities that led to a sweeping financial crisis. And more recently in 2015-2016, we saw volatility in the energy sector amid a glut of supply. When global oil prices were high, and US shale oil held a flood of promise, oil and gas companies issued lots of debt. Oil prices plummeted, and paying back that debt became a problem.
Therefore as it relates to credit markets, we think it is critical to perform fundamental research at the issuer level when selecting securities. In addition, analyzing these broader trends and potential catalysts will play an important role in managing fixed-income portfolios going forward.