Topic Tags: Fixed Income - Below Investment Grade

Keep Your Eye on the Ball

When it comes to baseball, successful hitters have little trouble hitting the ball when they know what pitch is coming. But when pitchers can vary the speed as well as the spin and curve of the ball, hitting becomes exponentially more difficult. An effective curveball can make even the most accomplished hitter look feeble.

As we look at the second half of 2024, we are reminding our clients to “keep their eye on the ball.” Indeed, the first half of the year has been pretty “hittable” as far as returns are concerned, with the majority of asset classes positive through June 30. However, curveballs such as Fed policy, equity index concentration, exchange rates, and a capricious election could quickly flip the script and send investors back to the dugout shaking their heads.

With that said, here is our scouting report for the second half of the year, organized by asset class. We share not only “down the middle” themes but also the curveballs that could flummox performance. A well-prepared investor is no different than a well-prepared baseball player: Insight and realistic expectations provide the foundation for a successful season!

2024 Halftime Market Insights

This video is a recording of a live webinar held July 23 by Marquette’s research team analyzing the first half of 2024 across the economy and various asset classes and themes we’ll be monitoring over the remainder of the year.

Our quarterly Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real assets, and private markets, with commentary by our research analysts and directors.

Featuring:
Greg Leonberger, FSA, EA, MAAA, FCA, Director of Research, Managing Partner
Frank Valle, CFA, CAIA, Associate Director of Fixed Income
David Hernandez, CFA, Director of Traditional Manager Search
Evan Frazier, CFA, CAIA, Senior Research Analyst
Hayley McCollum, Research Analyst
Chad Sheaffer, CFA, CAIA, Senior Research Analyst

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If you have any questions, please send our team an email.

1Q 2024 Market Insights Video

This video is a recording of a live webinar held April 25 by Marquette’s research team analyzing the first quarter of 2024 across the economy and various asset classes and themes we’ll be monitoring in the coming months.

 Our quarterly Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real assets, and private markets, with commentary by our research analysts and directors.

Featuring:
Greg Leonberger, FSA, EA, MAAA, FCA, Director of Research, Managing Partner
Frank Valle, CFA, CAIA, Senior Research Analyst
Catherine Hillier, Research Analyst
David Hernandez, CFA, Director of Traditional Manager Search
Evan Frazier, CFA, CAIA, Senior Research Analyst
Michael Carlton, Research Analyst
Amy Miller, Senior Research Analyst
Chad Sheaffer, CFA, CAIA, Senior Research Analyst

 

Sign up for research alerts to be invited to future webinars and notified when we publish new videos. If you have any questions, please send us an email.

Mind the Gap

Any ride on the London Tube reminds riders to mind the gap: Beware the space between train car and platform as you board and depart the train. A recent trip to London brought this phrase back to me and it seemed like a perfect description of how to look at financial markets this year, with the “gap” serving as the difference between expectations and reality, most particularly in terms of interest rate cuts.

In our market preview, we identified the Fed pivot as a primary driver of financial markets this year, most especially how expectations of cuts would line up with actual Fed policy. Going into the year, the market had priced in at least five cuts, which helped fuel a furious fourth quarter rally and investor optimism for 2024. One quarter in, however, those expectations have been turned on their head. Hotter than expected inflation and jobs reports in March have created a “higher for longer” narrative with the market expecting no more than two cuts during the second half of the year. Some economists have taken an even more bearish stance, suggesting there will not be any cuts. Overall, rates rose across the curve during the quarter as current U.S. debt levels sustained the long end of the curve while the short end was relatively unmoved.

Intuitively, many investors would expect such a big change in rate expectations to weigh heavily on markets, both equities and bonds. In that sense, equity performance was surprising during the first quarter, as the upward trend from 2023 continued. Predictably, bonds suffered as rates rose, but below investment grade sectors were profitable. To be fair, though, it should be noted that equities have endured a difficult start to this month, down 4.6% through April 22 as the higher for longer narrative has gained momentum.¹

Going forward, what should we watch for from asset classes as we venture into a market environment that looks much different than what we were expecting only three months ago?

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 rate hikes sparked concern that higher interest rates would lead to demand destruction and ultimately economic contraction. Nonetheless, here we are in the first quarter of 2024 and although the growth rate of gross domestic product has fallen, it is still positive. Unemployment remains at historic lows and inflation is falling. However, with the Fed unlikely to cut rates during the first half of the year and the full effect of the higher rate environment not yet settled, the recession threat still looms over the economy and markets. Given this background, the following paper presents three reasons for each side as to whether the U.S. may enter or avoid a recession in 2024, as well as recessionary implications across asset classes.

Show Some Maturity

As interest rates remain elevated, some market participants have questioned the extent to which the maturity wall in the below investment grade fixed income market is a sign of increased risk. On paper, concerns related to the maturity wall are understandable, as high yield and leveraged loan issuers face higher financing costs due to increased credit risk. Further, these companies could struggle to refinance debt as it matures and, as a result, incur much higher interest expenses in the future. These dynamics may lead to an eventual increase in default rates and create headwinds for fixed income performance.

In recent time, however, there have not been significant issues when it comes to below investment grade issuers refinancing debt and extending maturities. Since the beginning of 2023, the amount of high yield and leveraged loan debt maturing in 2024, 2025, and 2026 has been reduced by a combined $472 billion, which constitutes roughly 17% of the current market for outstanding high yield bonds and leveraged loans. Additionally, the pace of refinancings and the reduction in impending maturities has only accelerated over the more recent term, as issuers took advantage of lower interest rates in the fourth quarter of last year to term out debt. To that point, more than $54 billion of high yield and leveraged loans have been refinanced over the past three months alone. This is roughly double the pace of 2022, during which $28 billion was refinanced every three months, and nearly five times the $11 billion being refinanced every three months in 2021, during which the market for new issuance was almost non-existent.

Although refinancings abound in 2024, concerns related to impending maturities are not entirely unfounded. Over the next three years, over 21% of the below investment grade market is scheduled to mature. While this number is down slightly from year-end, it remains close to recent-term highs. However, this increased pace of refinancings is a welcome sign for fixed income markets broadly. Fundamentals remain resilient in the below investment grade space, and this resilience will likely allow companies to bear higher interest costs and continue to extend out maturities to time periods that may exhibit more rate favorability.

A Primer on Alternative Credit

Alternative credit, also referred to as private credit or private debt, has emerged as an area of significant interest for investors in recent time, offering attractive returns and distinct advantages compared to liquid credit markets across an array of strategy offerings. Over the last decade, alternative credit managers have stepped in to play a critical role within lending markets as traditional lenders (i.e., banks) have retreated in the face of liquidity constraints, more stringent regulatory requirements, and higher borrowing costs. As bank retrenchment has intensified, non-traditional credit providers have gained further prominence by offering stable, efficient, and long-term sources of funding for borrowers while also generating attractive returns for investors. Indeed, the leveraged credit market has grown rapidly since the Global Financial Crisis, evolving into a return-enhancing asset class with diversification benefits relative to public fixed income. Given current trends related to supply and demand for capital, as well as the efficiency with which providers can supply favorable loans within corporate capital structures, we expect alternative credit strategies will continue to offer attractive opportunities for investors going forward. However, while the broad opportunity set is particularly attractive, it is important to note that there are many types of strategies that fall into the alternative credit category, and each of these strategies offers varied risk, return, and liquidity characteristics. As it relates to risk broadly, investors should understand how the economic cycle, illiquidity risks, default rates, and increasing competition for deal flow can impact the asset class.

While Marquette has been an active participant in alternative credit markets for many years, the proliferation of the asset class and the expansion of offerings available to investors of different profiles serve as an impetus to examine the space in further detail. The aim of this whitepaper is to provide a background on the alternative credit space, highlight some of the key drivers of return and risk across various alternative credit strategies, and outline the prospects of the asset class going forward.

2024 Market Preview Video

This video is a recording of a live webinar held January 25 by Marquette’s research team analyzing 2023 across the economy and various asset classes as well as what trends and themes we’ll be monitoring in the year ahead.

Our quarterly Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real assets, and private markets, with commentary by our research analysts and directors.

Featuring:
Greg Leonberger, FSA, EA, MAAA, FCA, Director of Research, Managing Partner
Frank Valle, CFA, CAIA, Senior Research Analyst
Catherine Hillier, Research Analyst
David Hernandez, CFA, Director of Traditional Manager Search
Evan Frazier, CFA, CAIA, Senior Research Analyst
Griffin Gildea, Associate Research Analyst
Hayley McCollum, Research Analyst
Chad Sheaffer, CFA, CAIA, Senior Research Analyst

 

Sign up for research alerts to be invited to future webinars and notified when we publish new videos. If you have any questions, please send us an email.

2024 Market Preview: A 40 Degree Day

A former colleague once described his brother-in-law to me as a “40 degree day.” The puzzled look on my face revealed my unfamiliarity with the term, so he went on to ask me: “When does anyone get upset about a 40 degree day?” I laughed and shook my head — it was genius, the perfect way to describe something more forgettable than memorable…not especially good or bad, just average.

Given what markets have been through over the last four years — COVID, outsized returns both good and bad, record inflation, sky-rocketing interest rates, geopolitical conflict, and elevated volatility — I know I’m not alone in hoping that 2024 market returns will resemble a 40 degree day. Indeed, an “average” year of returns across markets will equate to positive portfolio performance for most asset allocations and allow investors to satisfy their risk and return goals.

Of course, there are potential stumbling blocks to a “normal” year. In particular, we will closely watch the Fed pivot and the disparity between expected and actual rate cuts, geopolitical conflicts, and the U.S. presidential election.

With that as background, we offer our annual outlook across asset classes, highlighting trends and themes for the year ahead. Happy reading and here’s to a year of normalcy!

Many Happy Returns: A Look Back at 2023

After a challenging 2022, during which significant drawdowns were exhibited by equity and fixed income indices alike, last year saw resurgent performance from most areas of the public market landscape. U.S. stocks were higher in 2023, with the S&P 500 and Russell 2000 indices posting returns of 26.3% and 16.9%, respectively, during the year. Key themes within domestic equity markets in 2023 included increased investor interest in GLP-1 obesity drugs, which led to strong performance from large-cap healthcare companies like Eli Lilly, as well as advances within the field of artificial intelligence. These advances resulted in narrow market leadership for much of 2023 and helped fuel a strong 42.7% calendar year return for the Russell 1000 Growth Index, which is home to each of the “Magnificent Seven” companies (Amazon, Apple, Alphabet, Meta, Microsoft, Nvidia, and Tesla) that were ultimately some of the largest beneficiaries of AI-related fervor. Some may have expressed skepticism that U.S. equity markets would exhibit such robust calendar year returns in March of 2023, which saw a banking crisis that led to the shuttering of Silicon Valley Bank, Signature Bank, and First Republic Bank amid an aggressive monetary tightening campaign by the Federal Reserve and widespread runs on deposits. Fortunately, concerns about broader contagion were allayed when the Fed announced plans to protect uninsured deposits at the affected institutions, though performance of mid- and small-cap indices did suffer due to these events.

Non-U.S. equities posted gains in 2023 as well, with the MSCI EAFE and EAFE Small-Cap indices, which track developed market stocks, returning 18.2% and 13.2%, respectively. UK stocks, while still positive for the year, lagged the broad market due to economic stagnation and higher borrowing costs. Japanese equities, on the other hand, served as a bright spot within the developed market space given recent shareholder-friendly corporate governance reforms and monetary policy that continues to be accommodative. The MSCI Emerging Markets Index was positive for the year as well, notching a return of 9.8%. Companies domiciled in Latin American countries like Brazil and Mexico were some of the largest gainers within non-U.S. markets during the year, as many have benefited from a reconfiguration of global supply chains and favorable population demographics. Additionally, the Taiwanese company TSMC, which is the largest constituent of the MSCI EM Index, exhibited strong performance in 2023 thanks to the enthusiasm surrounding AI advances detailed above. Despite these positive outcomes, the 2023 return of the EM benchmark was hampered due to continued challenges faced by China, which was among the worst performing countries during the period. Indeed, a slump in its property sector, ongoing geopolitical issues, a weak job market, and widespread debt stress in the corporate space have spelled trouble for China’s economy in recent time, however, many believe the nation’s slowdown has bottomed.

Fixed income indices were also positive in 2023 after a dismal 2022, with falling inflation, a resilient economy, and expectations of interest rate cuts on the horizon leading to a bond market rally to end the year. To that point, the yield on the 10-year Treasury, which sat above 5.0% less than three months ago, has now dropped to below 3.9%. Thanks in part to these dynamics, the Bloomberg Aggregate Index notched a return of 5.5% in 2023, while high yield bonds (+13.4%) and bank loans (+13.0%) posted their best calendar year performance figures since 2019 and 2009, respectively.

It is important to note that private markets asset classes, including private equity and real estate, report performance on a lagged basis, meaning full calendar year returns for these spaces will not be available for some time. In the coming weeks, Marquette will be providing more detailed analysis related to both public and private market performance in 2023, as well as what investors might reasonably expect in the new year. We encourage clients, in tandem with their consultants, to review these analyses, as well as existing investment exposures and policy targets, to ensure the appropriate positioning of portfolios in 2024 and beyond. Finally, as it relates to the new year, we wish all readers many happy returns!

 

Benchmarks:
Core Bond: Bloomberg Aggregate Index
High Yield: Bloomberg High Yield Index
Bank Loans: CS Leverage Loan Index
Broad U.S. Equities: Russell 3000 Index
Large Cap: S&P 500 Index
Mid Cap: Russell Mid Cap Index
Small Cap: Russell 2000 Index
Broad Intl Equities: MSCI ACWI ex-USA Index
Intl Large Cap: MSCI EAFE Index
Intl Small Cap: MSCI EAFE Small Cap Index
Emerging Markets: MSCI Emerging Markets Index
Commodities: S&P GSCI