These days, the economic picture has been decidedly cloudy. There was the bruising and divisive presidential election, accompanied by an uptick in COVID-19 cases around the U.S., which led to fresh concerns of how a recovery will play out. Although these worries have been recently tempered by the rollout of a coronavirus vaccine, companies continue to find it hard to think about investing for the future.
In turn, they have responded to this uncertain economic environment by tightening their belts, says Greg Peters, head of multi-sector and strategy at PGIM Fixed Income. Peters believes that from a credit perspective we are in a situation where companies are managing for bondholders. “I see conservatism in the C-suite,” he says. “And companies will continue to be quite conservative from a balance sheet management perspective.”
That’s good news for fixed income investors since companies typically react to uncertainty by reining in the spending that can occur during boom periods in the economy. “In a feel-good macro environment, bondholders typically are put to the side,” Peters says. “But when you have uncertainty, it can help creditors.”
A Crucial Ingredient
Companies showing fiscal prudence isn’t the only reason bond investors should find the credit market appealing. In fact, Peters—who also serves as a portfolio manager for several PGIM multi-sector fixed income strategies—believes that we are on the cusp of what he calls a “golden age of credit,” in which corporate debt will be a crucial ingredient for many fixed income investors’ portfolios.
The transition into this new era for credit markets began, Peters says, in early 2020, as the coronavirus pandemic swept across the world. Coming into 2020, credit sectors were richly valued, but the broad downturn in the financial markets knocked those valuations down quickly. “It was unprecedented,” Peters says. “It went from very rich to very cheap in two weeks.”
While some segments of the credit markets have recovered, returning to fully valued territory, Peters believes valuations remain attractive in select areas. For example, BBB- and BB-rated bonds belong to what Peters calls the “crossover corridor” between investment-grade bonds and lower-rated issues. He notes that investors may underestimate how flexible many of these corporate issuers could be when it comes to maintaining their credit rating. “These are well-established companies that can cut dividends, sell businesses or pull back on capex,” he says. “They have multiple levers they can pull to preserve their credit rating and their cash flow.”
What To Watch For
While the Federal Reserve’s low-rate stance has fueled fears of higher inflation, Peters doesn’t expect it to pose a challenge to bond investors. He notes that the current low levels of inflation predate both COVID-19 and the Fed’s recent pledge to keep interest rates at historic lows for the next few years.
That low inflation likely means the Fed will continue to be accommodative and keep supply high in the Treasury market. Meanwhile, Peters says, investors globally see plenty of appeal in Treasury rates—particularly compared to many other sovereign bonds that carry negative yields. For instance, 10-year Treasurys recently yielded 0.79%. In comparison, similar bonds issued in Germany and France yielded -0.61% and -0.30%, respectively.1
Still, the real rate environment is likely to continue drawing fixed income investors to riskier assets, such as corporate debt. Peters sees opportunities in subsectors including renewable energy, which is likely to see an uptick once the Biden administration takes office in 2021. Other areas of the energy sector such as natural gas may also perform well amid the continued decline in oil production. He’s also bullish on the consumer durables and consumer discretionary sectors as long as Congress passes another economic package in response to the continuing pandemic.
Peters suggests fixed income investors interested in boosting exposure to the credit markets do so by considering a bond strategy whose managers are skilled at weighing the idiosyncratic risks and opportunities of each sector and each issuer. After all, exposure to this area of the fixed income market offers an appealing blend of yield, return and safety, Peters says. “This negative real rate environment is driving investors into risk assets,” he says. “I think investors will continue to be interested in the credit side of fixed income.”
1 “Long-term interest rates,” Organisation for Economic Co-operation and Development (OECD). As of October 2020.
This video is for informational and educational purposes only and should not be construed as investment advice or an offer or solicitation in respect to any products or services. Investing involves risk, including possible loss of principal. Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Past performance does not guarantee future results. Asset allocation and/or diversification do not assure a profit or protect against a loss in declining markets.
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1046137-00001-00 Ed: 03/2021
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