Webinar Replay - Road To Recession? Riding Out Tightening Credit MarketsWebinarReplay-RoadToRecession?RidingOutTighteningCreditMarkets

The global economy has been resilient against a variety of headwinds, underpinning a recovery in risk assets. Despite optimism over a soft landing, the threat of recession remains in play. Elevated levels of inflation, higher interest rates and stricter lending standards are keeping up the pressure on consumers and businesses. Facing this uncertainty, investors need a playbook for riding out tightening credit markets.

PGIM gathered a panel of investment experts from across its affiliates to examine the outlook for the global economy and monetary policy, the impact of tighter borrowing conditions on asset classes, and the opportunities and risks emerging in the current environment. The following is a summary of the discussion.

• Macro outlook: An inverted yield curve has served as a recession signal in past cycles. This time around, there are some differentiating factors to consider. One such factor is that recent growth has been fueled by rising employment, rather than a dependence on debt. The typical boom-and-bust cycles of the past have featured credit expansion during times of low rates, followed by a credit crunch and a collapse in growth. The current environment is beginning to look more like the 1990s, when the economy remained resilient as rates rose. Today’s moderate-growth environment is proving to be durable in the face of war, supply-chain disruptions and higher rates. As inflation declines, the corresponding increase in real incomes will be positive for consumption. Europe may be one outlier, as signs of stagnation and greater inflation risk create a more difficult backdrop.
• Fixed income: With central banks nearing the end of their rate hikes, investors can expect less volatility in fixed-income markets, which should encourage a search for yield. This in turn should result in tighter credit spreads and solid performance from a range of non-government credit sectors, including structured products and emerging market debt, as well as investment-grade and high-yield corporate bonds. Importantly, a flat or inverted yield curve typically occurs at or near a peak in long-term interest rates, suggesting we are in the vicinity of—or just past—the peak strategic buy point of the cycle for bonds.
• Real estate: Valuations across real-estate markets began to correct last summer, coinciding with the increase in rates. While cracks have emerged, real estate is in a better position when compared to the Global Financial Crisis (GFC) because investors have greater clarity on what lies ahead. The focus is shifting to rental growth and opportunities emerging from broader global trends, which will be supportive of areas like hospitality and data centers. Advancements in AI will only increase demand for data centers, and the market is still in the beginning of this digital transformation. Long-term performance in the office sector presents higher risk than other asset classes, even with remote-work trends playing out differently in the US, Europe and Asia. Overall, with valuations recalibrating and liquidity tightening, there are attractive opportunities on the debt side of the real-estate market, which may offer a low risk profile when considering that strong incomes will be supportive of valuations catching up in the long run.
• Secondaries: It appears that many of the investments made by private equity funds have weathered the rise in interest rates well so far as the managers refinanced them when rates were low, so there is no need to refinance again in the next few years. However, higher rates and low M&A activity have contributed to a negative cash-flow pattern. When rates were low, fund managers often tapped credit lines to finance investments. As soon as rates spiked, those funds called on investors to pay back those credit lines, which resulted in low distributions while investors still had to provide capital. Unlike the GFC, today’s vibrant secondary market allows investors to proactively manage their PE portfolios. Investors looking to generate liquidity, or transform existing liquidity into attractive returns, can turn to the secondary market.