Spreads Largely Pricing in a Full Recovery

May 26, 2021

Two line charts showing Bank Loan and High Yield Spreads. Chart subtitle: Bank loan and high yield spreads are now tighter than they were pre-pandemic. First chart description: Left y-axis shows Bank Loan Spreads, ranging from 0bp to 2,500bp. X-axis shows months in two-month increments, from December 2019 to April 2021. Second chart shows the same for High Yield Spreads. Lines in each chart are the same industries: Energy (Beat-Up), Retail (Beat-Up), Transportation (Beat-Up), Financial (More Stable), Tech (More Stable), and Utilities (More Stable), with descriptors applied to those industries that fared better or worse throughout the early 2020 COVID panic. In both charts, all industries spiked in March 2020 and have since fallen to pre-pandemic levels. Chart source: Credit Suisse Leveraged Loan Index 3-year discount margin over LIBOR and High Yield Index Spread over Treasuries.

Spreads for industries that were beat-up during the early 2020 COVID panic — energy, retail, and transportation — as well as for industries that proved more stable — financials, technology, and utilities — are now generally tighter than pre-pandemic levels in the bank loan and high yield markets. From here, spreads could tighten further as issuer fundamentals continue to improve, widen in a correction, or be volatile, blowing out and tightening back in throughout the economic recovery.

While a lot of progress has been made on the vaccination front, there is still more work to do. The fully vaccinated rate in the U.S. is currently 39%, not yet at 70% herd immunity. Globally, the fully vaccinated rate is only 5%, not even close to 70% herd immunity. While this leaves the economic recovery vulnerable, markets are forward-looking. In the bank loan and high yield markets, maturities have been pushed off, which is a positive, thanks to the large volume of issuance over the past year. Leverage levels of bank loan and high yield issuers are currently high, but due to decline, another positive, as earnings rise in the economic recovery. Use of proceeds from bank loan and high yield issuances¹ and aggressive issuance² are at benign levels, and defaults have been declining — more positive indicators. On the negative side, equity valuations are already at all-time highs and continuing to rise.

In summary, fundamentals are attractive, but valuations are not. We could potentially see spreads tighten further, but uncertainty is high, and we could also see a correction given the high valuations and frothy sentiment. While further spread tightening will be accretive to returns, it will limit short-term future price appreciation for fixed income strategies. Overall, this is a dynamic that bears watching, particularly as economic growth accelerates and the pandemic continues to fade.

Print PDF > Spreads Largely Pricing in a Full Recovery

¹ Such as towards refinancings (a sign of conservativism) versus acquisitions and LBOs (a sign of frothiness).
² Such as CCC bank loan and high yield issuance and 2nd lien bank loan issuance.

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Related Content

04.11.2024

First to Cut: The Fed or the ECB?

Based on implied probabilities derived from options markets, investors are currently forecasting an 82% chance that the European Central Bank…

04.10.2024

1Q 2024 Market Insights Webinar

— LIVE WEBINAR APRIL 25 — Please join Marquette’s research team for our 1Q 2024…

04.01.2024

Sweet and High Up

Chocolate eggs and bunnies may have appeared more expensive to shoppers this Easter weekend, as the price of cocoa futures…

03.27.2024

The Crystal Ball Has Clouded

Last month, Marquette published a Chart of the Week that highlighted the aberrational length of the current…

03.26.2024

Assessing the Likelihood of a Recession and Understanding the Impact on Portfolios

Is a recession coming to the U.S.? It’s a question that has been asked since 2022, as the Fed’s rapid…

03.21.2024

The Dynamic Duo

In 2023, investors were stunned by the robust performance of seven prominent mega-cap stocks deemed the “Magnificent Seven.” Largely beneficiaries…

More articles

Subscribe to Research Email Alerts

Research Email Alert Subscription

Research alerts keep you updated on our latest research publications. Simply enter your contact information, choose the research alerts you would like to receive and click Subscribe. Alerts will be sent as research is published.

We respect your privacy. We will never share or sell your information.

Thank You

We appreciate your interest in Marquette Associates.

If you have questions or need further information, please contact us directly and we will respond to your inquiry within 24 hours.

Contact Us >