Credit Markets Expert Says Taking Advantage of Prices Today is a Risk Worth Taking

After several tumultuous weeks, global financial markets continue to be severely impacted by coronavirus contagion. In these unprecedented times, no one can say that they have lived through market conditions quite like the ones we are currently experiencing. No matter how many cycles we have been through, it is never the same. The duration of this downturn is still unknown despite many opinions being expressed. The fact of the matter is that no one knows what the future holds. The state of the credit markets is no exception.

Compared with many other financial asset classes, the credit markets, and the loan market in particular, held in longer against the recent drop in prices. However, credit markets were not immune to the unparalleled sell-off that had a very large technical and liquidity-driven element to it. Credit markets seem to have exited the panic phase and are now more thoughtful and focused as investors begin assessing winners and losers. Default and loss expectations have increased nevertheless, we believe these will be concentrated in sectors and issues with direct virus and oil exposure as well as issuers who were lower quality, smaller and over-leveraged prior to the arrival of the economic shutdowns. The default and loss scenarios being priced into credit markets today are draconian in our view. Furthermore, at current spread levels the math suggests that it is difficult to not make money over the coming one- and two-year periods.

Historical Forward Returns of Loans by Spread Level

Uncertainty remains elevated and we cannot say when volatility will subside however, many good companies have been thrown out with the bathwater and there is currently a big difference between price and value. Additionally, in our experience, prices bottom before sentiment. We believe that an investable opportunity in loans has formed for disciplined and methodical investors.

During times of uncertainty and high volatility it is our opinion that investors should consider higher quality over lower quality, debt over equity, income strategies over non-income strategies, performing issues over non-performing issues, and shorter dated risk over longer dated risk. In the loan market specifically, there remain many opportunities to invest in issues that possess these attributes at levels that were not available even two months ago. To paraphrase Warren Buffet, “…buy when others are fearful.” Furthermore, two observations strike me these days 1) most pundits, journalists and investors are projecting new price lows and wider spreads (we know that usually means markets will surprise the consensus) and 2) at the same time, many are talking about “all the great opportunities available today.” Regrettably, many are just talking and not doing anything. Could a scenario be forming that, once the virus is behind us, we snap back without a new low and 90% of the talkers miss “the opportunity of a lifetime”? Just a thought.

Policy makers have very quickly thrown enormous amounts of fiscal and monetary support at the economy and markets which, in my opinion, probably means that we have seen the lows The virus appears to be peaking and markets seem to be moving on from the terrible toll this disease has taken on the world. Investors are now beginning to focus on the reopening of the economy. On the other hand, investors are currently looking across the valley and may not be appreciating that the journey will be winding as winners and losers emerge. It is still unclear when financial markets will settle however, we believe that credit valuations have a remarkable risk reward profile at current prices.

To us bottom picking is fool hardy. Market timing in credit will likely also prove illusive. Price recoveries tend to be short and violent making timing almost impossible. We think disciplined selection of strong relative value is the only approach that will likely prove successful when investing in credit. On certain days we are going to feel like geniuses and other days we will not. We will have to get comfortable being uncomfortable. However, deploying capital today is a risk that, with twelve months hindsight, we feel many will have wished they had taken.