April 18, 2024 • 39 mins
Corporate debt markets are poised to perform well provided monetary policy doesn’t get tighter, according to Morgan Stanley. “As a credit investor, the thing that matters most is that the next Fed policy action is not a hike,” Vishy Tirupattur, the bank’s chief fixed income strategist, tells Bloomberg News’ James Crombie and Bloomberg Intelligence’s Spencer Cutter. “The bar for a hike is very high,” he adds. Morgan Stanley still expects three rate cuts from the Federal Reserve this year, starting in July. Tirupattur favors leveraged loans, CCC rated bonds and debt from companies in the energy sector. Also in this podcast, Tirupattur discusses the private credit opportunity and commercial real estate risks.
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Episode Transcript
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Speaker 1 (00:18):
Hello, and welcome to the Credit Edge, a weekly markets podcast.
My name is James Crombie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome Vishy Turripeteur, chief
fixed income strategist at Morgan Sanley. How are you, Vichy?
Speaker 2 (00:30):
Hi, James, thanks for having me.
Speaker 1 (00:32):
Thank you so much for joining us today. We're excited
to dig into your market views and the outlook. Also
delighted to welcome back Spencer Cutter with Bloomberg Intelligence. Great
to see you again, Spencer. So just to set the
scene a little here, credit markets are coming under pressure
as government yields keep going up, but barnes spreads are
still very tight. You're not getting very much compensation for
the risk of default or downgrade. Data on the US
(00:54):
economy is coming in hot, pushing treasury yields higher, making
corporate barnes look more attractive than they have for years.
So demand is high. There are some signs of froth
in the marketplace, which I expect we'll be talking about
a bit later. At the same time, we're seeing record
levels of bond and loan issuance. US companies have a
lot of refinancing to do, and they're taking advantage of
a window to raise debt. There's also a boom in
(01:16):
private markets, asset based finance and structured debt. Treasurers and
CFOs have a lot of options open to them. The
consensus on credit for this year remains pretty bullish, founded
on a belief that the US economy will avoid recession.
Most companies can afford to pay the higher current borrowing
costs as earnings remain strong. Fundamentally, companies appear to be
(01:37):
in a good place. On the other hand, though, there
is also a lot to worry about, from commercial real
estate to war, geopolitics and elections. Plus inflation definitely hasn't
gone away. That may mean no rate cuts at all
this year, and total returns, at least on the barn
side have turned negative. So Bishi, let's start with you.
(01:58):
What do you make of all this? Is it really
the year of the bond or the golden age of credit?
As a lot of people on this show keep telling us,
what's your view?
Speaker 2 (02:04):
I think we are very constructive on credit. I think
it's a very challenging environment for sure, As you described,
there are lots of uncertainties about you know, when do
the rate cut survive, how many date cuts we would get,
and how long the policy is in continue, and how
does the economy and inflation growth, et cetera pan out.
(02:27):
I think why credit stands out in a very positive
manner here. I think first first and foremost is that
if we're thinking about an economy that is ruling that's
stronger than what we anticipated, that is good for company earnings,
and in turn, it's good for the fundamentals of credit markets.
Number two, companies have over the last twenty one we
(02:55):
should a lot of debt, particularly fixedates. We should a
lot of debt both in investment mad and in high
yel so the mere term refinancing needs are fairly limited.
And the in the last year or so, there's been
considerable work done in the markets to chop down the
so called maturity walks. So maturity challenges today in the
(03:17):
credit markets, in the in the corporate credit markets don't
appear that uh demanding at this point. Very important is
that the credit curve is not inverted. You know, if
you look at the treasury curve, the inversion in the
treasury curve makes it a negative carry track. Even if
(03:39):
you have the expectation that the longer term yields or
or not insane? Can you expect longer term meals to
go down? There is you're taking a risk of a
negative carry as big as long as the front end
is meaningfully higher than the longer end. In credit, on
the other hand, is a positive carry trick meaning credit
curve is positively slowed. Scary and rule that works very
(04:02):
much for credit doesn't quite work for the treasury market
at this point. So that puts credit overall in a
pretty good place. Can you add on top of this
the conditions for you know, the capital markets are wide open,
the financial conditions are there with the if there are
as you said earlier, there are if a company wants
(04:22):
to borrow, there are multiple avenues for companies to borrow.
All of this boats really well for credit investors at
this point.
Speaker 1 (04:31):
So to talk about rates, So what's your current view?
We have everything from you know, three cuts this year
to actually an increase at some point and not not
not to distant future. What's your what's your view rates?
Speaker 2 (04:43):
Our view on rates is that in the course of
twenty twenty four, we expect to see three our base cases,
we expect to see three rate cups starting in July
and skipping September and having another twenty five basic point
raid cut in November as well as in this so
three rate cuts this year, three rate cuts in twenty
twenty five. As a as a credit investor, the thing
(05:07):
that matters most is that the next FED policy action
is not a hike, and we don't. We think the
bar for a hike is very high. As long as
the next move is not, I think credit will do
well even if there are the you know, the rate
cuts are fewer and arrive later. Credit will do well
(05:31):
as long as the next move again is not a hike.
Speaker 1 (05:35):
And to get those rate cuts, you expect the economy
to slow significantly such that the FED fields that it
needs to ease a little bit.
Speaker 2 (05:41):
We expect some slowing. We know. We have revised how
much flowing from our year ahead outlook that we published
in November. In November, we were expecting that the twenty
twenty four see GDP glows in the US. Of the
one point six percent that we have now divides it
up to two point three percent. It is still a
slower growth from the taste of growth in twenty three,
(06:05):
but not as much as much as slower as we
had thought earlier. So good strong growth is good for credit.
Let's not forget that strong growth is good for credit.
Speaker 3 (06:17):
Hey, this Spencer Cutter call from Bloomberg Intelligence. On that note,
quick question for you, I guess what do you think
when it comes to rate cuts from the FED? What
is more important is that inflation or their economic growth?
Because I'm sitting here thinking, you know, roll the calendar
back to December, and everybody expected the FED would have
(06:39):
already cut rates at least once, if not twice, by now.
But here we are and they haven't cut And there's
even some people saying that think the next move now
could be a rate hike, And that's largely because inflation
data is coming in stronger than people had thought it
might at this point. So I guess, if the economy
is slowing down but inflation is still three four or
(07:01):
five percent, what does the FED do?
Speaker 2 (07:05):
Well? The first thing is that we don't expect inflation
to be three four five percent. We expect inflation too,
to come down to two six percent by the end
of the year. And in that world where and we
think predominantly to come down from not only goods related
deflation or this inflation. We expect to see some slowing
(07:27):
of the services led inflation as well. So the path
to that desilvation inflation is going to be bumpy, and
it's been perhaps bumpier than what we had expected it
to be. But the trajectory, as long as the trajectory
of inflation is downward, we expect that the FED will
(07:50):
will be cutting because the issue of how long does
the economy need to continue to be under continued molecule
thing that will be the question that the FED has
to content with. And we would say that, you know, uh,
the economy turns out as we are, as we are
(08:10):
expecting it to, we will see inflation coming down. Where
we would be wrong is that this path changes and
we end up having a reaccelevation of the pace of
inflation and we do get to three five percent as
you as you contended just now, that is definitely a challenge.
I don't expect FED to be cutting under those worlds.
(08:32):
In that world and I would also say that the
bar for the next move to be hyped, in our opinion,
is very high, very high from being achieved. So maybe
the Federal beyond hold for longer is a greater likelihood
than the next move being the hype.
Speaker 1 (08:50):
So what does that there's a credit spread specially, I mean,
they've been very very tight for the last few months.
They've widened out over the last few days. But if
I look at your bull came in the most recent research,
that would suggests, you know, the spreads are going to
go below eighty for ig, which is very very tight
in history.
Speaker 2 (09:07):
It is tight, but it's you know, historically speaking, and
when we do expect that under if all of these conditions,
the case for our bullcase to pan out as you
as we laid out is not outside the realm of possibilities.
That's quite possible. And while spreads are tight historically speaking,
they are not at the tightest levels. You know, while
(09:30):
you look at the last thirty years of CREATE spread data,
the types for US investment need credit in the mid nineties,
ninety six, ninety seven times by time train fifty eight
basis points. I'm not suggesting that you go to fifty eight,
but I just want to highlight that why credit spreads
are tight relative to the recent history, they are not
(09:51):
at the tightest relative to a longer term history.
Speaker 1 (09:55):
And they're also very tight on the high yield side.
I mean that sort of begs the question if you
look at spreads sort of compensation for on the IG
side downgrade risk and on the high yield side to
fault risk, are you getting compensated enough? Do you think
for the for all the risks that we've sort of outlined,
which is the.
Speaker 2 (10:12):
Better compensation in the high healed space is in loans
as opposed to bonce, So leverage loans versus high ed
bonds is we think is a better place to be.
You know, remember, leverage loans are floating weight instruments, and
because they're floating rate, the effect of the five hundred
and fifty basis points of monetary policy tightening has already
(10:32):
been felt in the in the leveraged loans space, and
there is a clearly what I would call a positive
survivorship bias in leverage loans. In other words, if a
company has endured fie hundred and fifty business points of tightening,
it is quite likely that the company is going to endure,
especially if the next policy move is not that of
(10:55):
a tightening and more that of a easing. Under that world,
we think that the you know, if you put it
in that that in that perspective, the challenges in the
high yelled bond market are greater because high yell bond
markets have not high companies that are dependent on fixed
(11:16):
rate high yell bond financing have not, for the most part,
experienced this effect of higher rates. There they is shued
a lot of debt in twenty twenty, twenty twenty, and
twenty twenty one, and they have not had to issue
much debt or they have not. Their coupons have significantly
below today. So if they were to refinance in twenty
(11:38):
six or twenty seven or twenty five, twenty six, twenty seven,
the sticker shock or high healed bonds would be meaningful.
On the other hand, for levels loans the fund the
next move is a cut in you know will and
expect to see there the pressure on interest coverage that
we have seen start to eaither bet and if you've
(12:00):
seen the downraade cycle, the downtlaates cycle peat in the
middle of last year. So we now expect that the
you know we've been seeing for a couple of quarters
where the upgrade downlade ratio has moved in favor of
upgrades and leverage loans. You add to that that the
robust return of the clo market. The structured credit market
(12:21):
is an important buyer base in leveraged loans. A robust
new issue market in the loans is most very positively
for the levis. So within the higher space, we like
leverage loans much more than we.
Speaker 1 (12:36):
Like high box and clearly, as you said, they've outperformed
bonds over the last certainly year today and in over
the last year, perhaps because they are floating and rates
have just kept going up. But at the same time,
you know, if you look at the racing agencies outlooks
for defaults, the loan default rate expectation is much higher. Also,
the recovery rate is much lower than it has been
(12:57):
compared to history. Are we not kind of underplaying the
risks a bit and loans?
Speaker 2 (13:02):
Well, I don't think so. I think the recovery dates
will be much lower. In our expectations, recovery rates will
be close to fifty percent compared to the long term
recovery dates that you've seen of over seventy percent. So
our calculations already incorporate meaningfully lower recovery dates in the
cycle compared to the past cycles. The second we think
(13:26):
that downrates and defaults are on the way down. The
peak in downrates in the loan space, downraates, particularly downrates
into triple fees, we think have peaked about the middle
of last year, and the upgrades downrat ratio has shifted
in favor of upgrades today, and we expect that the
(13:47):
defour rates have also peaked or we are pretty close
to the peak of defaur rates, and over the course
of the rest of the year, we expect default rates
to keep coming down, especially if the growth stands up,
you know, and we continue to see this growth in
economic growth that we are seeing upside surprises to growth
that should translate into stronger company earnings. All of that
(14:10):
put together, we should see better outcomes in terms of
default and taking into account lower account dates, valuation we
think is still attractive and lows.
Speaker 3 (14:20):
Hey vitiate Spencer again the question for you, since we're
talking about the syndicated loan market. In in my prior
life before Bloomberg, I spent a lot of time underwriting
and helping to syndicate leveraged loans, and that was long
enough ago that we didn't really have to compete much
with the private credit market. I know that that has
(14:41):
been a growing part of the financial market of the
last several years. I'm curious what impact, if any, you
see that having on the traditional syndicated loan market and
where you see the private credit market going.
Speaker 2 (14:54):
I think private credit market is here today. There are
a few things I would say. I think the credit
market is both a competitor to the broadly syndicated loan
market as well as complimentary to the broadly syndicated loanmarket.
How is that. I think it is competitive in the
sense that in a periods where execution uncertainty becomes greater
(15:18):
in the broadly syndicated markets. The kind of execution uncertainty
both in terms of, you know, getting deals done and
the timing of deals that we saw in say twenty
twenty twenty three, even investors were faced with, you know,
a very monetary policy, monetary policy that were tightening and
financial conditions that were not that conducive. There was a
(15:41):
fair amount of execution uncertainty private credit markets because there
is no syndication involved, because there are one or two
lenders typically involved in a deal, you had a much
better outcome, so they could get an execution certainty and
that means higher spread for the borrowers and tougher covenants
(16:03):
for the lenders, both of those things in a market
where financial conditions are much easier, which is the case today,
private credit markets, which had gained share relative to the
public broadly syndicated loan market, some of that trail would
be given the gain shared would be given up this year.
But there is another part of the market for companies
(16:27):
that are too small to access the broadly syndicated loan market,
or companies that are way down in the distress market,
so say companies that are in B minus or negative
watch or triple C raated companies looking for definancing. The
broadly syndicated loan market is probably not very open to
those things. Because the biggest buyer of leverage loans, the clos,
(16:50):
have a allocation stuper triple c There is a particular
feature in the clos that dissuade them from buying triple
se loans. As a result of that, the levels the
broadly syndicated leverage loan market doesn't have a great bid
for an exit in the for the triple C rate loans,
So for those loans, private markets have really stepped in.
(17:14):
So in the sense that private credit pard the advent
of private credit has made the pie bigger. You know,
it's you know, the over pie is bigger. The share
of the private credit versus public credit will ever flow
depending on the market conditions, but the overall amount of
credit available to leverlish within the leveraged finances space is
(17:36):
actually bigger because of private credit, and I think it
also has the effect of smoothing out default cycles. So
because for you know, absent private credit for deeply distressed names,
there was no other exit. And now because of private credit,
there is a peaceable exit. Even it's an expensive exit,
(17:57):
but it's an exit. So that means that the companies
can title ork and that and prevent default. So put
all these things together, I think credit is here to
stay and place both competitive rule as well as a
complimentary all to the broadly syndicated markets.
Speaker 1 (18:15):
So as a quick.
Speaker 3 (18:16):
Follow up on that then, so you know, in the past,
when I've seen new products enter the market or new
new markets being open and they grow rapidly, usually there's
a law that's been on that has yet to be uncovered.
And as the market grows and everything's good, nobody knows
quite what that flaw is. I'm curious if there's a
(18:38):
flaw in the private credit market that we don't know
about yet, because everything's been kind of going relatively well
in the market since private credit really kind of came
on the scene, but it's been growing rapidly, and I'm wondering,
you know, what is what is the not maybe not
a fatal flaw, but you know, something that people might
find rears its head that they weren't expecting. I guess
(19:01):
my my initial thought is liquidity. If you do have
a downturn some particularly some of the larger loans, h
is there going to be a market for the lenders
to be able to manage their portfolios or because these
are private are they just kind of stuck with it?
And does that become an issue?
Speaker 2 (19:20):
Actually, well, let me let me put it this say,
I don't think private credit is a panacea that solves
bad businesses. You know, if a company has if there's
an underlying business model, is a challenge business model, I
don't think private credit will resolve it or solve them.
That's having means the liquidity in related issues. In fact,
(19:45):
their private credit actually completely constructible. Is if a company
isn't it in some form of distressed, you know, because
of some external or something external happening that's an ordinous
event that causes some distrust to the particular company. It
(20:05):
is in a broadly syndicated market to resolve that distress
to intervention is much harder a because covenants are broader.
Syndicated laws are really no maintenance covenants. It's really incorrence
covenants only, so you can't really capture it. And in
the private credit market, because the covenant language is much stronger,
covenants act as a circuit breaker for for that bad
(20:27):
outcome to come through. And since you are only negotiating
with one or two lenders, the ability of private lenders
to step in to with additional capital, and we've seen
multiple examples from this is there and we as a
result of this, we think it's not I think these
the fact that there are one or two lenders only
(20:51):
makes the resolution of challenges in perrect credit market much easier.
But all that said, done down, we have to be careful.
That mean, look, there is a lot of there's not
a tremendous amount of transparency in the private credit market
and obviously these are types. So we think it's it
pays to for investors to dig into the details, understand
(21:15):
the credit and try to you know, you know, we've
done some deep dive on private credit recently within the
quality of the credit compares to low single bees tople
ce type of equal in credit in the public markets.
As you know, most private credit are not rated, so
you need to dig into and find the right metrics
to compare. And also keep in mind that the while
(21:37):
the default experience in the private credit market that we
observed doesn't show that the default experience is meaningfully higher,
it's not that different than the default experience in the
broad lea syndicated market. But that data point really reflects
the last five years. We don't have a much longer
(21:59):
time series our experience of you know, how private credit
has behaved in multiple cycles. So I would say that
there are for all these good reasons for private credit
to play an important, positive, constructive role. But you have
to be always be aware in terms of the of
the quality of underwriting and taking you know, understanding the
(22:24):
underlying credit in as much detail as possible.
Speaker 1 (22:27):
Is there any danger that visually that it's kind of
distorting the pricing in the public markets in that it's
taking away supply and if you look at the way
that you know, we've seen such a such an increase
in demand and relatively you know, thin net supply, which
may be keeping spreads very tight. And if you take
the supply into the shadow banks and into private credit,
does that not make that equation worse and sort of
(22:49):
distort the whole risk pricing?
Speaker 3 (22:52):
Not?
Speaker 2 (22:52):
Not exactly in my mind. I think in during the
twenty twenty two twenty three when we saw a big
you know, much more tightness in the in the public markets,
you know, financial condition being tightened, private credit entering uh
entering the fray, we saw significantly higher risks semia in
(23:12):
the in private credit relative to public credit. And today
public credit through broadly syndicated loans in particular, or the
markets are open and competing very strongly with the private
trade market. So I don't think that the the you know,
the the fact of private credit itself creates you know,
(23:37):
additional risks in the system. And I think as as always,
private credit or public credit is not a panasy up
in a badman's model, so they will be defaulted in
companies if there are bad business business models and encountering
challenging economic circumstances and experience thus far is that that
(23:58):
default experience is not significantly different credit. Again, I would
warrant that that that experience we have is about the
last five years.
Speaker 1 (24:08):
So on on sectors she has. Reading your most recent reports,
amongst other things, you flag energy is an opportunity and
that's obviously in the headlines at the moment because of
geopolitics and oil is going up, and it's possibly an
inflation risk and so on. But you mentioned opportunities in
both equity and credit. I wanted to just focus in
on the credit opportunities and and and sort of try
(24:30):
and ask you to expand a bit more on on
what the opportunities are and you know, how does how
does a bond investor take advantage of this move?
Speaker 2 (24:39):
I think a strong oil oil market certainly boats very
positively for the fundamentals of the of companies, the energy companies,
And we think this boats true for both the oil
predominantly oil driven players as well as for the natural
gas players. We think the natural gas players, where prices
(25:01):
have actually been you know, more on the downward trajectory,
there has been significant belt tightening that actually happened in
the in the in those E n P type of players.
So we think that the the stronger oil markets, you know,
is that you know, improves the fundamentals of the of
(25:22):
energy oil players, and that translates into lower you know,
expectations of weakness and of credit and therefore we should
expect to see some some upgrades. All this conditions continued
to statement the system upgrades and energy space, so all
of that really translates into us being constructive for what
(25:46):
it is worth. We are constructive on energy stops with well,
so energy stocks were constructive and by extension, what's good
for stocks is also probably good in this case because
of the discipline that forced after twenty fifteen within in
these conditions and under these conditions or is good for
(26:08):
energy stocks and also tensationto being good for energy bonds.
That's you know, I think, especially energy bonds that are
in the double b cusppy range of investment WAID just
below investment read and we should expect to see some
upgrade potential there as well.
Speaker 3 (26:29):
H Spencer Again, so just to want to jump in
to play Devil's avget, I guess since I'm a credit
or energy focused credit analyst, and so I totally agree
that from a fundamental standpoint, the sector seems to be
in perhaps its best shape it's been in in quite
some time, as companies have spent a lot of time
(26:52):
since twenty twenty downturn, in particular fixing their balance sheets
using free cash flow, the paydown debt, equity funded mergers,
et cetera. Where I struggle though, is credit spreads are
already at within the energy space, and whether you want
to look at high yield or investment grade and independent
producers or the energy market overall, we're within, you know,
(27:15):
spitting distance of the lowest credit spreads we've seen in
a decade or more. Most of the companies that have
been focused on paying down debt have kind of reached
the point where they're done with that. For maybe there's
a few bucks left that they're going to pay down,
but vast majority of the free cash flow that's being
(27:35):
generated today is going out the door to shareholders in
the form of stock buybacks and variable dividends. So I've
been sort of looking at this and saying, I can't
see a particular bare case scenario except for maybe some
of the high old natural gas players where you know,
natural gas prices where they are today, it's just unsustainable
(27:56):
for anybody in the long term. We'll see how long
that plays out the market recovers, But yeah, that I
don't really see what major barecase. But I have a
really hard time rationalizing any upside here because, like I said,
I don't think if if oil prices stay at eighty
bucks or more, everyone's gonna be generating a lot of
free casual Even if you have a spike above one
(28:17):
hundred due to some geopolitical event, it strikes me that
the vast majority of that is going to go out
the door to shareholders and you know, not necessarily benefit creditors.
Speaker 2 (28:29):
I don't I don't have a you know, strong pushback
to the setup that you you lay out there. The
only point I would make is that the the you know,
energy borrowers have done, you know I've never had to do,
and they have done a significant amount of balance in
repair in over the course of the last few years.
(28:51):
And as long as credit I mean, as long as
oil types of stay in this range or or go higher,
and certainly stay about eight, I think they're underlying uh,
you know, underlying castles will be pretty robust. And our reason,
our expectation is that we will near term expectations that
we'll see some some more higher oil prices. So as
(29:13):
long as we stay in this world, which we think
there is a very good case to be made that
oil prices will stay in above eighty. Actually we are
our base cases ninety four to the near term. I
don't see a challenge for the for the for the
energy bonds. And you know, our credit spreads tight. Credit
(29:34):
spreads are indeed tight, and they have been tight. And
I would say that the putting in the you know,
if I can go back to a point I was
made making earlier, we'll think that the better opportunity within
the credit space overall leverage finance spaces and in the
loans versus high boss, that's that remains. So that having
(29:55):
been said, if you're looking for opportunities within the high space,
in know, if your investment date is limited to how
you bonds, I think Energy still has positive technical, positive technicals,
and positive fundamentals ahead.
Speaker 1 (30:11):
So the other big coll that kind of stood out
for me in your recent report that she was you know,
besides leverage loans, you like triple C rated bonds. That's
something that a lot of people tend to stay away
from you know, they like everything else in credit apart
from that because they think that's where the most defaults
are going to be. Obviously, but given your duvish view
and and you know the way the where the equity
(30:33):
markets are performing, I mean, it seems to make sense.
But but do you are you very selective there? And
how do you play triple c's right now?
Speaker 2 (30:41):
I think the argument for triple c's is really a
valuation of them. So if you compare where the credit
where credit stacks out across the the across the you know,
credit spectrum, you know the place where the way we
look at it is that where credit spreads in across
(31:02):
various parts of the credit structures in relative to a
long term history, triple c's are about the fifty percentile
of the last twenty year range. And you compare that
to you know, higher bonds for example, are you know,
closer to ten percent of the ten ten percentile of
(31:23):
the last twenty year range investment we had credit maybe
twelve thirteen percent. So by all of those metrics, the
rest of the parts of the market, from IG to
high single age, double b's, triple bs, et cetera, look
at their very tight end evaluation. The one thing that
stands out is really the triple c's triple CS that
(31:45):
you know, over seven hundred basis points stands out in
the middle of that of the twenty year range. So
the argument for triple c's is a valuation argument. And
the next augument is that is the growth in particularly
earnings growth that we're predicting. So we are predicting that
twenty twenty four will see high single digit seventy eight
(32:07):
percent type of earning growth in SMB five hundred a
fifteen to twenty fifteen seventeen percent earnings growth in twenty
twenty five. So against that background of you know, not
not rich, not cheap, in the middle of the range
valuations and with the with the the tail winds of
improving earnings, we think that's that is what makes the
(32:31):
case for triple.
Speaker 1 (32:32):
Ceas are there any parts of that market that you
just avoid, you know, sexor wise.
Speaker 2 (32:38):
Actually, once you get to triple cs, you need to
do work on a name by name basis, and as
opposed to I would rather not take a sector view
on on triple CS, and it's really a name by
name basis. You have to do the work on triple season.
Speaker 1 (32:52):
Okay, and talking of other areas of risk, I mean
you did some great writing recently on commercial real estate,
which we'vebviously looked at in great details of subjects of
great interests for readers. What's your takeaway. I mean, obviously
there are problems, you know, the individual level, but is
there a bigger problem there? I mean, if you some
(33:12):
of our guests have said that hundreds of banks in
the US may fail because of it. Is that is
that going to bleed through to the rest of the
credit market.
Speaker 2 (33:20):
I think there is no doubt that the regal banking
system has a substantial exposure to commercial real faith. And
I will now and given the regularly environment ahead for
the smaller regional banks, the underlying business model is clearly
under the threat, and that the commercial real estate exposure,
(33:41):
which is disproportionately higher with the smaller banks, makes that
challenge very very difficult to overcome. That having been said,
we think this is the way I would describe caustial
real the state challenge. It is not it does not
leach to a systemic risk level. You know, in my
mind commercial real estate that is not systemic, but a
(34:04):
persistent risk. So our distinguish it been systemic risk and
persistent risks. So we will. The commercial real estate challenges
are not going to be over tomorrow next year. They
will be there for some time to come. We have
a significant valuation adjustments that need to happen, a secular
change in office as a property that has occurred. You know,
(34:25):
we have to all the eventual evaluations will have to
reflect these significant changes that occurred. That will take time,
so we will. We will keep talking about commercial real
estate for some time to come. But I think that
it does not raise to the systemic risk issues that
some people are worried about.
Speaker 1 (34:47):
Is there anything out there that worries you mean, we're
a credit show, so we worry about everything. I'm sure
Spencer is just sitting there worried about other stuff. But
what really concerns you visually about the outlook for credit
this year?
Speaker 2 (34:59):
I think the key that worries me is if the
next policy move is not a cut, But if the
next policy move is a hike, a pause, or a cut,
I am less worried about a hike. I am most
certainly worried about.
Speaker 1 (35:13):
So the base case is just to lean into the risk. Basically,
leverage loans and triple cs. Is that is that the takeaway?
Speaker 2 (35:21):
I mean, leverage known triples are some of the spots,
but overall, I think the one takeaway from this discussion,
if you would, if you remember, would be that credit,
broadly speaking, is a positive carry asset and that stands
in tart contrast to other assets within fixed income, in
particular the rate market. So the positive carry boats particularly
(35:45):
well for credit. And you, you know, you add all
the other factors, both technical and fundamentals that I've described,
and that that makes the augument robust. But the positive
carry is something that's the key driver here.
Speaker 1 (35:59):
Are there any sign of frust in your mind?
Speaker 2 (36:01):
I think when you're discussing faut, I think you need
to keep in mind that credit investing requires an understanding
of credit and the fundamentals of credit. So this market
in the last ten years has been predominantly a macro
driven market. I think we have now transitioned into what
(36:24):
is really a credit pickers market. The two credit market
fundamentals are really valuable today as opposed to a beta
from the larger what the FED does, what the ECB did,
or what the Q program or all of those factors
are far less relevant going forward, and two credit picking
(36:45):
becomes the most important aspect, and two credit pickers or
two credit pickers, this is an idea market.
Speaker 1 (36:53):
When I talked to Byside, is you know big portfolio
managers about spreads being so tight. I mean they say
it doesn't really matter, and then in a person a
bit and they say, well, it doesn't matter until it does,
by which they mean it doesn't matter until there's a
big vole event. There are many things out there, you know, geopolitics,
there are some big elections coming up. There are many
things out there that could cause of volatility, you know,
(37:15):
ripping event that the effects credit? How do you position
for that? How do you hedge against that? How do
you how do you view that as a risk.
Speaker 2 (37:23):
The way I look at it is, you know, exorginant shocks,
whether geopolitical or elsewhere you know or other sources of
exoging shocks would affect all risk markets, and credit markets
are by no means an exception to this. We think
that for all the reasons we've discussed, fundamental and technical
credit markets are better able to withstand some of those
(37:45):
exorginant shocks, not all of them. Some of those exhaust shocks,
credit markets can stand better, and they're not entirely dependent
on great cups. They are. They are dependent on the
next move not being a hike, but the timing and
the magnitude of matters less for credit than for other
macro markets. So in that sense, credit markets vulnerability to
(38:09):
exhort in the shocks is absolutely there and the right
opportunities to hedge. There are several instruments available to hedge,
and I think careful risk management is absolutely the the
you know, absolutely critical, has never been more critical than
it is today, even all the various potions that could happen.
(38:30):
But when we are taking a bigger picture of view
fixed income in general, credit in particular, it seems like
a pretty attractive pace to be here.
Speaker 1 (38:41):
Great stuff the sh Tirpreteur Chief Fixed Income Stretchest that
Morgan Sandy has been a pleasure having you on the
Credit Edge.
Speaker 2 (38:46):
Many thanks thanks for having me. Look forward to doing
this again.
Speaker 1 (38:49):
And Spencer Cussid with Bloomberg Intelligence, thank you very much
for being back on the show.
Speaker 2 (38:53):
Thank you.
Speaker 3 (38:54):
James Harpley do it check.
Speaker 1 (38:56):
Out all of Spencer's excellent analysis on the Bloomberg terminal,
and please do subscribe wherever you get your podcasts. We're
on Apple, Spotify, and all other good podcast providers, including
the Bloomberg Terminal. Give us a review, tell your friends,
or email me directly at jcrombieight at bloomberg dot net.
I'm James Crombie. It's been a pleasure having you join
us again. Next week on the Credit Edge,
Hello, and welcome to the Credit Edge, a weekly markets podcast.
My name is James Crombie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome Vishy Turripeteur, chief
fixed income strategist at Morgan Sanley. How are you, Vichy?
Speaker 2 (00:30):
Hi, James, thanks for having me.
Speaker 1 (00:32):
Thank you so much for joining us today. We're excited
to dig into your market views and the outlook. Also
delighted to welcome back Spencer Cutter with Bloomberg Intelligence. Great
to see you again, Spencer. So just to set the
scene a little here, credit markets are coming under pressure
as government yields keep going up, but barnes spreads are
still very tight. You're not getting very much compensation for
the risk of default or downgrade. Data on the US
(00:54):
economy is coming in hot, pushing treasury yields higher, making
corporate barnes look more attractive than they have for years.
So demand is high. There are some signs of froth
in the marketplace, which I expect we'll be talking about
a bit later. At the same time, we're seeing record
levels of bond and loan issuance. US companies have a
lot of refinancing to do, and they're taking advantage of
a window to raise debt. There's also a boom in
(01:16):
private markets, asset based finance and structured debt. Treasurers and
CFOs have a lot of options open to them. The
consensus on credit for this year remains pretty bullish, founded
on a belief that the US economy will avoid recession.
Most companies can afford to pay the higher current borrowing
costs as earnings remain strong. Fundamentally, companies appear to be
(01:37):
in a good place. On the other hand, though, there
is also a lot to worry about, from commercial real
estate to war, geopolitics and elections. Plus inflation definitely hasn't
gone away. That may mean no rate cuts at all
this year, and total returns, at least on the barn
side have turned negative. So Bishi, let's start with you.
(01:58):
What do you make of all this? Is it really
the year of the bond or the golden age of credit?
As a lot of people on this show keep telling us,
what's your view?
Speaker 2 (02:04):
I think we are very constructive on credit. I think
it's a very challenging environment for sure, As you described,
there are lots of uncertainties about you know, when do
the rate cut survive, how many date cuts we would get,
and how long the policy is in continue, and how
does the economy and inflation growth, et cetera pan out.
(02:27):
I think why credit stands out in a very positive
manner here. I think first first and foremost is that
if we're thinking about an economy that is ruling that's
stronger than what we anticipated, that is good for company earnings,
and in turn, it's good for the fundamentals of credit markets.
Number two, companies have over the last twenty one we
(02:55):
should a lot of debt, particularly fixedates. We should a
lot of debt both in investment mad and in high
yel so the mere term refinancing needs are fairly limited.
And the in the last year or so, there's been
considerable work done in the markets to chop down the
so called maturity walks. So maturity challenges today in the
(03:17):
credit markets, in the in the corporate credit markets don't
appear that uh demanding at this point. Very important is
that the credit curve is not inverted. You know, if
you look at the treasury curve, the inversion in the
treasury curve makes it a negative carry track. Even if
(03:39):
you have the expectation that the longer term yields or
or not insane? Can you expect longer term meals to
go down? There is you're taking a risk of a
negative carry as big as long as the front end
is meaningfully higher than the longer end. In credit, on
the other hand, is a positive carry trick meaning credit
curve is positively slowed. Scary and rule that works very
(04:02):
much for credit doesn't quite work for the treasury market
at this point. So that puts credit overall in a
pretty good place. Can you add on top of this
the conditions for you know, the capital markets are wide open,
the financial conditions are there with the if there are
as you said earlier, there are if a company wants
(04:22):
to borrow, there are multiple avenues for companies to borrow.
All of this boats really well for credit investors at
this point.
Speaker 1 (04:31):
So to talk about rates, So what's your current view?
We have everything from you know, three cuts this year
to actually an increase at some point and not not
not to distant future. What's your what's your view rates?
Speaker 2 (04:43):
Our view on rates is that in the course of
twenty twenty four, we expect to see three our base cases,
we expect to see three rate cups starting in July
and skipping September and having another twenty five basic point
raid cut in November as well as in this so
three rate cuts this year, three rate cuts in twenty
twenty five. As a as a credit investor, the thing
(05:07):
that matters most is that the next FED policy action
is not a hike, and we don't. We think the
bar for a hike is very high. As long as
the next move is not, I think credit will do
well even if there are the you know, the rate
cuts are fewer and arrive later. Credit will do well
(05:31):
as long as the next move again is not a hike.
Speaker 1 (05:35):
And to get those rate cuts, you expect the economy
to slow significantly such that the FED fields that it
needs to ease a little bit.
Speaker 2 (05:41):
We expect some slowing. We know. We have revised how
much flowing from our year ahead outlook that we published
in November. In November, we were expecting that the twenty
twenty four see GDP glows in the US. Of the
one point six percent that we have now divides it
up to two point three percent. It is still a
slower growth from the taste of growth in twenty three,
(06:05):
but not as much as much as slower as we
had thought earlier. So good strong growth is good for credit.
Let's not forget that strong growth is good for credit.
Speaker 3 (06:17):
Hey, this Spencer Cutter call from Bloomberg Intelligence. On that note,
quick question for you, I guess what do you think
when it comes to rate cuts from the FED? What
is more important is that inflation or their economic growth?
Because I'm sitting here thinking, you know, roll the calendar
back to December, and everybody expected the FED would have
(06:39):
already cut rates at least once, if not twice, by now.
But here we are and they haven't cut And there's
even some people saying that think the next move now
could be a rate hike, And that's largely because inflation
data is coming in stronger than people had thought it
might at this point. So I guess, if the economy
is slowing down but inflation is still three four or
(07:01):
five percent, what does the FED do?
Speaker 2 (07:05):
Well? The first thing is that we don't expect inflation
to be three four five percent. We expect inflation too,
to come down to two six percent by the end
of the year. And in that world where and we
think predominantly to come down from not only goods related
deflation or this inflation. We expect to see some slowing
(07:27):
of the services led inflation as well. So the path
to that desilvation inflation is going to be bumpy, and
it's been perhaps bumpier than what we had expected it
to be. But the trajectory, as long as the trajectory
of inflation is downward, we expect that the FED will
(07:50):
will be cutting because the issue of how long does
the economy need to continue to be under continued molecule
thing that will be the question that the FED has
to content with. And we would say that, you know, uh,
the economy turns out as we are, as we are
(08:10):
expecting it to, we will see inflation coming down. Where
we would be wrong is that this path changes and
we end up having a reaccelevation of the pace of
inflation and we do get to three five percent as
you as you contended just now, that is definitely a challenge.
I don't expect FED to be cutting under those worlds.
(08:32):
In that world and I would also say that the
bar for the next move to be hyped, in our opinion,
is very high, very high from being achieved. So maybe
the Federal beyond hold for longer is a greater likelihood
than the next move being the hype.
Speaker 1 (08:50):
So what does that there's a credit spread specially, I mean,
they've been very very tight for the last few months.
They've widened out over the last few days. But if
I look at your bull came in the most recent research,
that would suggests, you know, the spreads are going to
go below eighty for ig, which is very very tight
in history.
Speaker 2 (09:07):
It is tight, but it's you know, historically speaking, and
when we do expect that under if all of these conditions,
the case for our bullcase to pan out as you
as we laid out is not outside the realm of possibilities.
That's quite possible. And while spreads are tight historically speaking,
they are not at the tightest levels. You know, while
(09:30):
you look at the last thirty years of CREATE spread data,
the types for US investment need credit in the mid nineties,
ninety six, ninety seven times by time train fifty eight
basis points. I'm not suggesting that you go to fifty eight,
but I just want to highlight that why credit spreads
are tight relative to the recent history, they are not
(09:51):
at the tightest relative to a longer term history.
Speaker 1 (09:55):
And they're also very tight on the high yield side.
I mean that sort of begs the question if you
look at spreads sort of compensation for on the IG
side downgrade risk and on the high yield side to
fault risk, are you getting compensated enough? Do you think
for the for all the risks that we've sort of outlined,
which is the.
Speaker 2 (10:12):
Better compensation in the high healed space is in loans
as opposed to bonce, So leverage loans versus high ed
bonds is we think is a better place to be.
You know, remember, leverage loans are floating weight instruments, and
because they're floating rate, the effect of the five hundred
and fifty basis points of monetary policy tightening has already
(10:32):
been felt in the in the leveraged loans space, and
there is a clearly what I would call a positive
survivorship bias in leverage loans. In other words, if a
company has endured fie hundred and fifty business points of tightening,
it is quite likely that the company is going to endure,
especially if the next policy move is not that of
(10:55):
a tightening and more that of a easing. Under that world,
we think that the you know, if you put it
in that that in that perspective, the challenges in the
high yelled bond market are greater because high yell bond
markets have not high companies that are dependent on fixed
(11:16):
rate high yell bond financing have not, for the most part,
experienced this effect of higher rates. There they is shued
a lot of debt in twenty twenty, twenty twenty, and
twenty twenty one, and they have not had to issue
much debt or they have not. Their coupons have significantly
below today. So if they were to refinance in twenty
(11:38):
six or twenty seven or twenty five, twenty six, twenty seven,
the sticker shock or high healed bonds would be meaningful.
On the other hand, for levels loans the fund the
next move is a cut in you know will and
expect to see there the pressure on interest coverage that
we have seen start to eaither bet and if you've
(12:00):
seen the downraade cycle, the downtlaates cycle peat in the
middle of last year. So we now expect that the
you know we've been seeing for a couple of quarters
where the upgrade downlade ratio has moved in favor of
upgrades and leverage loans. You add to that that the
robust return of the clo market. The structured credit market
(12:21):
is an important buyer base in leveraged loans. A robust
new issue market in the loans is most very positively
for the levis. So within the higher space, we like
leverage loans much more than we.
Speaker 1 (12:36):
Like high box and clearly, as you said, they've outperformed
bonds over the last certainly year today and in over
the last year, perhaps because they are floating and rates
have just kept going up. But at the same time,
you know, if you look at the racing agencies outlooks
for defaults, the loan default rate expectation is much higher. Also,
the recovery rate is much lower than it has been
(12:57):
compared to history. Are we not kind of underplaying the
risks a bit and loans?
Speaker 2 (13:02):
Well, I don't think so. I think the recovery dates
will be much lower. In our expectations, recovery rates will
be close to fifty percent compared to the long term
recovery dates that you've seen of over seventy percent. So
our calculations already incorporate meaningfully lower recovery dates in the
cycle compared to the past cycles. The second we think
(13:26):
that downrates and defaults are on the way down. The
peak in downrates in the loan space, downraates, particularly downrates
into triple fees, we think have peaked about the middle
of last year, and the upgrades downrat ratio has shifted
in favor of upgrades today, and we expect that the
(13:47):
defour rates have also peaked or we are pretty close
to the peak of defaur rates, and over the course
of the rest of the year, we expect default rates
to keep coming down, especially if the growth stands up,
you know, and we continue to see this growth in
economic growth that we are seeing upside surprises to growth
that should translate into stronger company earnings. All of that
(14:10):
put together, we should see better outcomes in terms of
default and taking into account lower account dates, valuation we
think is still attractive and lows.
Speaker 3 (14:20):
Hey vitiate Spencer again the question for you, since we're
talking about the syndicated loan market. In in my prior
life before Bloomberg, I spent a lot of time underwriting
and helping to syndicate leveraged loans, and that was long
enough ago that we didn't really have to compete much
with the private credit market. I know that that has
(14:41):
been a growing part of the financial market of the
last several years. I'm curious what impact, if any, you
see that having on the traditional syndicated loan market and
where you see the private credit market going.
Speaker 2 (14:54):
I think private credit market is here today. There are
a few things I would say. I think the credit
market is both a competitor to the broadly syndicated loan
market as well as complimentary to the broadly syndicated loanmarket.
How is that. I think it is competitive in the
sense that in a periods where execution uncertainty becomes greater
(15:18):
in the broadly syndicated markets. The kind of execution uncertainty
both in terms of, you know, getting deals done and
the timing of deals that we saw in say twenty
twenty twenty three, even investors were faced with, you know,
a very monetary policy, monetary policy that were tightening and
financial conditions that were not that conducive. There was a
(15:41):
fair amount of execution uncertainty private credit markets because there
is no syndication involved, because there are one or two
lenders typically involved in a deal, you had a much
better outcome, so they could get an execution certainty and
that means higher spread for the borrowers and tougher covenants
(16:03):
for the lenders, both of those things in a market
where financial conditions are much easier, which is the case today,
private credit markets, which had gained share relative to the
public broadly syndicated loan market, some of that trail would
be given the gain shared would be given up this year.
But there is another part of the market for companies
(16:27):
that are too small to access the broadly syndicated loan market,
or companies that are way down in the distress market,
so say companies that are in B minus or negative
watch or triple C raated companies looking for definancing. The
broadly syndicated loan market is probably not very open to
those things. Because the biggest buyer of leverage loans, the clos,
(16:50):
have a allocation stuper triple c There is a particular
feature in the clos that dissuade them from buying triple
se loans. As a result of that, the levels the
broadly syndicated leverage loan market doesn't have a great bid
for an exit in the for the triple C rate loans,
So for those loans, private markets have really stepped in.
(17:14):
So in the sense that private credit pard the advent
of private credit has made the pie bigger. You know,
it's you know, the over pie is bigger. The share
of the private credit versus public credit will ever flow
depending on the market conditions, but the overall amount of
credit available to leverlish within the leveraged finances space is
(17:36):
actually bigger because of private credit, and I think it
also has the effect of smoothing out default cycles. So
because for you know, absent private credit for deeply distressed names,
there was no other exit. And now because of private credit,
there is a peaceable exit. Even it's an expensive exit,
(17:57):
but it's an exit. So that means that the companies
can title ork and that and prevent default. So put
all these things together, I think credit is here to
stay and place both competitive rule as well as a
complimentary all to the broadly syndicated markets.
Speaker 1 (18:15):
So as a quick.
Speaker 3 (18:16):
Follow up on that then, so you know, in the past,
when I've seen new products enter the market or new
new markets being open and they grow rapidly, usually there's
a law that's been on that has yet to be uncovered.
And as the market grows and everything's good, nobody knows
quite what that flaw is. I'm curious if there's a
(18:38):
flaw in the private credit market that we don't know
about yet, because everything's been kind of going relatively well
in the market since private credit really kind of came
on the scene, but it's been growing rapidly, and I'm wondering,
you know, what is what is the not maybe not
a fatal flaw, but you know, something that people might
find rears its head that they weren't expecting. I guess
(19:01):
my my initial thought is liquidity. If you do have
a downturn some particularly some of the larger loans, h
is there going to be a market for the lenders
to be able to manage their portfolios or because these
are private are they just kind of stuck with it?
And does that become an issue?
Speaker 2 (19:20):
Actually, well, let me let me put it this say,
I don't think private credit is a panacea that solves
bad businesses. You know, if a company has if there's
an underlying business model, is a challenge business model, I
don't think private credit will resolve it or solve them.
That's having means the liquidity in related issues. In fact,
(19:45):
their private credit actually completely constructible. Is if a company
isn't it in some form of distressed, you know, because
of some external or something external happening that's an ordinous
event that causes some distrust to the particular company. It
(20:05):
is in a broadly syndicated market to resolve that distress
to intervention is much harder a because covenants are broader.
Syndicated laws are really no maintenance covenants. It's really incorrence
covenants only, so you can't really capture it. And in
the private credit market, because the covenant language is much stronger,
covenants act as a circuit breaker for for that bad
(20:27):
outcome to come through. And since you are only negotiating
with one or two lenders, the ability of private lenders
to step in to with additional capital, and we've seen
multiple examples from this is there and we as a
result of this, we think it's not I think these
the fact that there are one or two lenders only
(20:51):
makes the resolution of challenges in perrect credit market much easier.
But all that said, done down, we have to be careful.
That mean, look, there is a lot of there's not
a tremendous amount of transparency in the private credit market
and obviously these are types. So we think it's it
pays to for investors to dig into the details, understand
(21:15):
the credit and try to you know, you know, we've
done some deep dive on private credit recently within the
quality of the credit compares to low single bees tople
ce type of equal in credit in the public markets.
As you know, most private credit are not rated, so
you need to dig into and find the right metrics
to compare. And also keep in mind that the while
(21:37):
the default experience in the private credit market that we
observed doesn't show that the default experience is meaningfully higher,
it's not that different than the default experience in the
broad lea syndicated market. But that data point really reflects
the last five years. We don't have a much longer
(21:59):
time series our experience of you know, how private credit
has behaved in multiple cycles. So I would say that
there are for all these good reasons for private credit
to play an important, positive, constructive role. But you have
to be always be aware in terms of the of
the quality of underwriting and taking you know, understanding the
(22:24):
underlying credit in as much detail as possible.
Speaker 1 (22:27):
Is there any danger that visually that it's kind of
distorting the pricing in the public markets in that it's
taking away supply and if you look at the way
that you know, we've seen such a such an increase
in demand and relatively you know, thin net supply, which
may be keeping spreads very tight. And if you take
the supply into the shadow banks and into private credit,
does that not make that equation worse and sort of
(22:49):
distort the whole risk pricing?
Speaker 3 (22:52):
Not?
Speaker 2 (22:52):
Not exactly in my mind. I think in during the
twenty twenty two twenty three when we saw a big
you know, much more tightness in the in the public markets,
you know, financial condition being tightened, private credit entering uh
entering the fray, we saw significantly higher risks semia in
(23:12):
the in private credit relative to public credit. And today
public credit through broadly syndicated loans in particular, or the
markets are open and competing very strongly with the private
trade market. So I don't think that the the you know,
the the fact of private credit itself creates you know,
(23:37):
additional risks in the system. And I think as as always,
private credit or public credit is not a panasy up
in a badman's model, so they will be defaulted in
companies if there are bad business business models and encountering
challenging economic circumstances and experience thus far is that that
(23:58):
default experience is not significantly different credit. Again, I would
warrant that that that experience we have is about the
last five years.
Speaker 1 (24:08):
So on on sectors she has. Reading your most recent reports,
amongst other things, you flag energy is an opportunity and
that's obviously in the headlines at the moment because of
geopolitics and oil is going up, and it's possibly an
inflation risk and so on. But you mentioned opportunities in
both equity and credit. I wanted to just focus in
on the credit opportunities and and and sort of try
(24:30):
and ask you to expand a bit more on on
what the opportunities are and you know, how does how
does a bond investor take advantage of this move?
Speaker 2 (24:39):
I think a strong oil oil market certainly boats very
positively for the fundamentals of the of companies, the energy companies,
And we think this boats true for both the oil
predominantly oil driven players as well as for the natural
gas players. We think the natural gas players, where prices
(25:01):
have actually been you know, more on the downward trajectory,
there has been significant belt tightening that actually happened in
the in the in those E n P type of players.
So we think that the the stronger oil markets, you know,
is that you know, improves the fundamentals of the of
(25:22):
energy oil players, and that translates into lower you know,
expectations of weakness and of credit and therefore we should
expect to see some some upgrades. All this conditions continued
to statement the system upgrades and energy space, so all
of that really translates into us being constructive for what
(25:46):
it is worth. We are constructive on energy stops with well,
so energy stocks were constructive and by extension, what's good
for stocks is also probably good in this case because
of the discipline that forced after twenty fifteen within in
these conditions and under these conditions or is good for
(26:08):
energy stocks and also tensationto being good for energy bonds.
That's you know, I think, especially energy bonds that are
in the double b cusppy range of investment WAID just
below investment read and we should expect to see some
upgrade potential there as well.
Speaker 3 (26:29):
H Spencer Again, so just to want to jump in
to play Devil's avget, I guess since I'm a credit
or energy focused credit analyst, and so I totally agree
that from a fundamental standpoint, the sector seems to be
in perhaps its best shape it's been in in quite
some time, as companies have spent a lot of time
(26:52):
since twenty twenty downturn, in particular fixing their balance sheets
using free cash flow, the paydown debt, equity funded mergers,
et cetera. Where I struggle though, is credit spreads are
already at within the energy space, and whether you want
to look at high yield or investment grade and independent
producers or the energy market overall, we're within, you know,
(27:15):
spitting distance of the lowest credit spreads we've seen in
a decade or more. Most of the companies that have
been focused on paying down debt have kind of reached
the point where they're done with that. For maybe there's
a few bucks left that they're going to pay down,
but vast majority of the free cash flow that's being
(27:35):
generated today is going out the door to shareholders in
the form of stock buybacks and variable dividends. So I've
been sort of looking at this and saying, I can't
see a particular bare case scenario except for maybe some
of the high old natural gas players where you know,
natural gas prices where they are today, it's just unsustainable
(27:56):
for anybody in the long term. We'll see how long
that plays out the market recovers, But yeah, that I
don't really see what major barecase. But I have a
really hard time rationalizing any upside here because, like I said,
I don't think if if oil prices stay at eighty
bucks or more, everyone's gonna be generating a lot of
free casual Even if you have a spike above one
(28:17):
hundred due to some geopolitical event, it strikes me that
the vast majority of that is going to go out
the door to shareholders and you know, not necessarily benefit creditors.
Speaker 2 (28:29):
I don't I don't have a you know, strong pushback
to the setup that you you lay out there. The
only point I would make is that the the you know,
energy borrowers have done, you know I've never had to do,
and they have done a significant amount of balance in
repair in over the course of the last few years.
(28:51):
And as long as credit I mean, as long as
oil types of stay in this range or or go higher,
and certainly stay about eight, I think they're underlying uh,
you know, underlying castles will be pretty robust. And our reason,
our expectation is that we will near term expectations that
we'll see some some more higher oil prices. So as
(29:13):
long as we stay in this world, which we think
there is a very good case to be made that
oil prices will stay in above eighty. Actually we are
our base cases ninety four to the near term. I
don't see a challenge for the for the for the
energy bonds. And you know, our credit spreads tight. Credit
(29:34):
spreads are indeed tight, and they have been tight. And
I would say that the putting in the you know,
if I can go back to a point I was
made making earlier, we'll think that the better opportunity within
the credit space overall leverage finance spaces and in the
loans versus high boss, that's that remains. So that having
(29:55):
been said, if you're looking for opportunities within the high space,
in know, if your investment date is limited to how
you bonds, I think Energy still has positive technical, positive technicals,
and positive fundamentals ahead.
Speaker 1 (30:11):
So the other big coll that kind of stood out
for me in your recent report that she was you know,
besides leverage loans, you like triple C rated bonds. That's
something that a lot of people tend to stay away
from you know, they like everything else in credit apart
from that because they think that's where the most defaults
are going to be. Obviously, but given your duvish view
and and you know the way the where the equity
(30:33):
markets are performing, I mean, it seems to make sense.
But but do you are you very selective there? And
how do you play triple c's right now?
Speaker 2 (30:41):
I think the argument for triple c's is really a
valuation of them. So if you compare where the credit
where credit stacks out across the the across the you know,
credit spectrum, you know the place where the way we
look at it is that where credit spreads in across
(31:02):
various parts of the credit structures in relative to a
long term history, triple c's are about the fifty percentile
of the last twenty year range. And you compare that
to you know, higher bonds for example, are you know,
closer to ten percent of the ten ten percentile of
(31:23):
the last twenty year range investment we had credit maybe
twelve thirteen percent. So by all of those metrics, the
rest of the parts of the market, from IG to
high single age, double b's, triple bs, et cetera, look
at their very tight end evaluation. The one thing that
stands out is really the triple c's triple CS that
(31:45):
you know, over seven hundred basis points stands out in
the middle of that of the twenty year range. So
the argument for triple c's is a valuation argument. And
the next augument is that is the growth in particularly
earnings growth that we're predicting. So we are predicting that
twenty twenty four will see high single digit seventy eight
(32:07):
percent type of earning growth in SMB five hundred a
fifteen to twenty fifteen seventeen percent earnings growth in twenty
twenty five. So against that background of you know, not
not rich, not cheap, in the middle of the range
valuations and with the with the the tail winds of
improving earnings, we think that's that is what makes the
(32:31):
case for triple.
Speaker 1 (32:32):
Ceas are there any parts of that market that you
just avoid, you know, sexor wise.
Speaker 2 (32:38):
Actually, once you get to triple cs, you need to
do work on a name by name basis, and as
opposed to I would rather not take a sector view
on on triple CS, and it's really a name by
name basis. You have to do the work on triple season.
Speaker 1 (32:52):
Okay, and talking of other areas of risk, I mean
you did some great writing recently on commercial real estate,
which we'vebviously looked at in great details of subjects of
great interests for readers. What's your takeaway. I mean, obviously
there are problems, you know, the individual level, but is
there a bigger problem there? I mean, if you some
(33:12):
of our guests have said that hundreds of banks in
the US may fail because of it. Is that is
that going to bleed through to the rest of the
credit market.
Speaker 2 (33:20):
I think there is no doubt that the regal banking
system has a substantial exposure to commercial real faith. And
I will now and given the regularly environment ahead for
the smaller regional banks, the underlying business model is clearly
under the threat, and that the commercial real estate exposure,
(33:41):
which is disproportionately higher with the smaller banks, makes that
challenge very very difficult to overcome. That having been said,
we think this is the way I would describe caustial
real the state challenge. It is not it does not
leach to a systemic risk level. You know, in my
mind commercial real estate that is not systemic, but a
(34:04):
persistent risk. So our distinguish it been systemic risk and
persistent risks. So we will. The commercial real estate challenges
are not going to be over tomorrow next year. They
will be there for some time to come. We have
a significant valuation adjustments that need to happen, a secular
change in office as a property that has occurred. You know,
(34:25):
we have to all the eventual evaluations will have to
reflect these significant changes that occurred. That will take time,
so we will. We will keep talking about commercial real
estate for some time to come. But I think that
it does not raise to the systemic risk issues that
some people are worried about.
Speaker 1 (34:47):
Is there anything out there that worries you mean, we're
a credit show, so we worry about everything. I'm sure
Spencer is just sitting there worried about other stuff. But
what really concerns you visually about the outlook for credit
this year?
Speaker 2 (34:59):
I think the key that worries me is if the
next policy move is not a cut, But if the
next policy move is a hike, a pause, or a cut,
I am less worried about a hike. I am most
certainly worried about.
Speaker 1 (35:13):
So the base case is just to lean into the risk. Basically,
leverage loans and triple cs. Is that is that the takeaway?
Speaker 2 (35:21):
I mean, leverage known triples are some of the spots,
but overall, I think the one takeaway from this discussion,
if you would, if you remember, would be that credit,
broadly speaking, is a positive carry asset and that stands
in tart contrast to other assets within fixed income, in
particular the rate market. So the positive carry boats particularly
(35:45):
well for credit. And you, you know, you add all
the other factors, both technical and fundamentals that I've described,
and that that makes the augument robust. But the positive
carry is something that's the key driver here.
Speaker 1 (35:59):
Are there any sign of frust in your mind?
Speaker 2 (36:01):
I think when you're discussing faut, I think you need
to keep in mind that credit investing requires an understanding
of credit and the fundamentals of credit. So this market
in the last ten years has been predominantly a macro
driven market. I think we have now transitioned into what
(36:24):
is really a credit pickers market. The two credit market
fundamentals are really valuable today as opposed to a beta
from the larger what the FED does, what the ECB did,
or what the Q program or all of those factors
are far less relevant going forward, and two credit picking
(36:45):
becomes the most important aspect, and two credit pickers or
two credit pickers, this is an idea market.
Speaker 1 (36:53):
When I talked to Byside, is you know big portfolio
managers about spreads being so tight. I mean they say
it doesn't really matter, and then in a person a
bit and they say, well, it doesn't matter until it does,
by which they mean it doesn't matter until there's a
big vole event. There are many things out there, you know, geopolitics,
there are some big elections coming up. There are many
things out there that could cause of volatility, you know,
(37:15):
ripping event that the effects credit? How do you position
for that? How do you hedge against that? How do
you how do you view that as a risk.
Speaker 2 (37:23):
The way I look at it is, you know, exorginant shocks,
whether geopolitical or elsewhere you know or other sources of
exoging shocks would affect all risk markets, and credit markets
are by no means an exception to this. We think
that for all the reasons we've discussed, fundamental and technical
credit markets are better able to withstand some of those
(37:45):
exorginant shocks, not all of them. Some of those exhaust shocks,
credit markets can stand better, and they're not entirely dependent
on great cups. They are. They are dependent on the
next move not being a hike, but the timing and
the magnitude of matters less for credit than for other
macro markets. So in that sense, credit markets vulnerability to
(38:09):
exhort in the shocks is absolutely there and the right
opportunities to hedge. There are several instruments available to hedge,
and I think careful risk management is absolutely the the
you know, absolutely critical, has never been more critical than
it is today, even all the various potions that could happen.
(38:30):
But when we are taking a bigger picture of view
fixed income in general, credit in particular, it seems like
a pretty attractive pace to be here.
Speaker 1 (38:41):
Great stuff the sh Tirpreteur Chief Fixed Income Stretchest that
Morgan Sandy has been a pleasure having you on the
Credit Edge.
Speaker 2 (38:46):
Many thanks thanks for having me. Look forward to doing
this again.
Speaker 1 (38:49):
And Spencer Cussid with Bloomberg Intelligence, thank you very much
for being back on the show.
Speaker 2 (38:53):
Thank you.
Speaker 3 (38:54):
James Harpley do it check.
Speaker 1 (38:56):
Out all of Spencer's excellent analysis on the Bloomberg terminal,
and please do subscribe wherever you get your podcasts. We're
on Apple, Spotify, and all other good podcast providers, including
the Bloomberg Terminal. Give us a review, tell your friends,
or email me directly at jcrombieight at bloomberg dot net.
I'm James Crombie. It's been a pleasure having you join
us again. Next week on the Credit Edge,
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