Even as economic and public health data get worse, recent changes in three key factors make global credit markets an attractive option. Our Chief Cross-Asset Strategist, Andrew Sheets, explains.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, April 3rd at 2:00 p.m. in London.
For much of the last three years, we've had a negative, underweight view on global credit markets. That view has now changed and I wanted to take a moment to discuss why we've become more optimistic about credit, even as economic and public health data continue to get worse.
Our negative view on credit was based on three factors. First, valuations were expensive, with the extra yield on many types of global credit near the low end of the historical range. Second, fundamentals appeared shaky as borrowers had taken on large amounts of debt in recent years. And third, it was our view on the economic cycle. Historically, credit is often at greatest risk when one is late in an economic expansion, as indicated by measures such as very low unemployment, very high consumer confidence, or a very flat yield curve. Until recently, we had all three.
But recently, each of these three concerns has shifted, enough that we think credit markets now have a positive outlook.
The first change has been to valuations. In the span of just two months, spreads on corporate and securitized credit have moved from some of their lowest levels, versus government bonds in the last decade, to some of their highest. Indeed, for investment grade rated corporate bonds in the United States, we estimate that spreads have only been higher than current levels twice in the last 100 years. Those times were the Great Depression and, briefly, during the Global Financial Crisis.
Next is fundamentals. While corporate debt levels are still historically high, valuations adjusted for that leverage are now attractive. Meanwhile, unprecedented levels of stimulus from central banks and governments should give businesses more breathing space. Indeed, the public sector, globaly, will be borrowing heavily to push more money into the private sector.
Finally, there's the economic cycle. As I mentioned previously, late in an economic expansion can be a risky time for corporate credit. But interestingly, once a recession has started and spreads have increased, history suggests that much of the risk to investment returns is behind you. There will still be defaults and downgrades, but so long as valuations already reflect this, and we think they do, the risk is mitigated.
While we think global credit valuations have improved broadly, we see the best risk reward in U.S. and European investment grade bonds. We think these markets offer solid valuations and have a greater ability to weather the economic uncertainty that, unfortunately, is set to continue.
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