The spirit of forgiveness extends to the debt markets, in Michele’s view, making the outlook for corporate insolvencies more favorable than it was after the housing bubble burst. He expects downgrades and default rates in the high-yield bond market to fall short of the 2008-2009 figures.
“Ratings agencies have decided to give companies 18 to 24 months to get their balance sheets back in shape,” he said in an October webcast. “Ninety-nine percent of corporate borrowers should be fine.”
Tolerance in the debt markets for afflicted borrowers was evident in the spring when companies in shut-down industries like cruise lines raised capital easily through debt, equity and convertible bonds. Michele told clients that distressed debt funds “are waiting to step in and restructure” companies that run into debt-service problems.
The cheap cost of debt issuance, however, could create its own set of issues. Corporate debt stands at about 48% of GDP, and Michele said it could rise to 60%. No matter how cheap it is, there is always the question of how much debt a company wants to carry.
Michele told the October webcast attendees that the biggest long-term fear is a resurgence of inflation. Globally, there has been $18 trillion in fiscal and monetary stimulus, as many central banks have embraced what academic economists call a form of Modern Monetary Theory, or MMT.
Loomis Sayles Vice Chairman Dan Fuss isn’t buying into the deflation argument promulgated by certain economists who project the Japanese and eurozone experiences onto the U.S. “Prices will be higher in four years,” he says. “How much no one knows.”
Like some others, Fuss believes that prices may be rising faster than the government is reporting. “In general, you are going to see purchasing power slide,” he says.
Weisman at MFS offers an example of this statistical mirage. Ordinary Americans are watching home sales surge and housing prices rise in many regions. But the housing factor that dominates the Consumer Price Index (CPI) is owners’ equivalent rent, not home prices, and the former is falling.
So what’s a fixed-income investor to do? The Federal Reserve has indicated it intends to keep interest rates at anemic levels for a long time, and would let inflation run at 2.5% without reacting. Then again, central banks spent most of the last decade trying to induce inflation with no success.
Collins at PGIM says Treasurys and agency mortgages should be avoided as they sport negative real yields. “The next few years will be the golden age of credit,” he argues.
Given the accommodative stance of the Fed, many professional bond investors see opportunities in the high-yield bond sector. While the Fed has purchased junk bond ETFs, it has said it won’t buy the debt of insolvent businesses. In a fast-changing economy, differentiating between leveraged companies that can pay their debt and those that can’t could prove challenging.
In a world starved for income, Bahuguna at Columbia Threadneedle notes demand for high-yield bonds is coming from inside and outside the U.S., where yields are even lower in some places. If the confluence of factors promoting credit creation might worry some investors, the markets remain receptive to each wave of new bond issues.
Much has been written this year about the inability of a classic 60-40 retirement portfolio to meet the needs of retirees and pensions. But Bahuguna believes it remains viable. Like Fuss, she slightly favors equities over bonds.
Fuss, who consults with pension clients for Loomis Sayles, says he is still comfortable with a 70-30 portfolio tilted toward income-oriented stocks like Merck and Pfizer that can “increase the dividend a little each year.” Yield-oriented stocks have one major advantage over bonds—their liquidity.
But he is telling pension funds they might want to lower their return expectations to the 3.7% to 4.0% area for the next 5 years. That might not be what advisors’ clients want to hear these days.