OVERVIEW
credit strategy outlook 2021
FIND OUT MORE
Download the full publication
(for existing clients)
In their 2020 Outlook report, our credit analysts warned that investors faced “A tale of two scenarios.” The more probable scenario, in their view, was that spreads would widen as US growth slowed. Spreads did widen, precipitously, but not for the reason they expected, yet the central bankers reacted to COVID-19 even more quickly than they did to the 2008 financial crisis and after a one month sell-off, spreads slowly recovered. Now as they write in late November, IG spreads are almost where they were this time last year.
Bullish on 1H21...
Valuations make our analysts nervous again. In their 3Q20 update they suggested that IG spreads could get to 100bp by year-end, but also warned that they would widen in 2021 as the defaults which should have come in 2020 finally materialised. But their views have changed since then, for three reasons:
...but still gloomy on 2H21
Spread tightening in 1H may sound optimistic, yet credit investors could find life frustrating in years to come. Carry will be scant, as spreads tighten and government bond yields stay low. And although spreads may not reflect it, credit risk will persist.
Why the soprano won't sing for a while
By continuing to use our website, you are accepting our use of cookies. The cookies we use are "analytical" cookies. They allow us to recognise and count the number of visitors and to see how visitors move around the site when they are using it. To find out more or to change your cookie preferences, please refer to our cookies policy.
#contentwithimpact
This page contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale, at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for use by institutional and professional investors and is not intended for retail investors. Investors should consider this report as only a single factor in making their investment decision.
© Societe Generale 2020
Cookies Policy
Legal Information
Contact
Three things we learned in 2020
We spend much time – perhaps too much time – theorising (and agonising) about the shape of the credit cycle. Prior to the financial crisis, a typical credit cycle would last eight years. After an 18-month sell-off, spreads would rally for two years, and then range trade for four.
Corporate liquidity is even stronger than they expected it to be six months ago. Earnings are weak, but operating cash cushion ratios indicate that companies should have enough cash to meet interest payments even if earnings fall further.
Monetary and fiscal policy in Europe will likely continue to prevent a spike in defaults. Instead, in an echo of Japan’s experience in the 1990s, they now expect a plateau of defaults between 5% and 6% per annum for the next four years.
ACCEPT
Our analysts see the market reversing course in 2H. Yet in this environment, security selection may matter more than the direction of the market as a whole. 2021 could turn out to be like 2005, in which performances were made (or broken) by positions in US autos.
High cash balances mean gross issuance will be lower than last year’s levels. As a result, primary supply net of central bank buying and net of redemptions should drop substantially, again for the second year in a row
Sell-offs and rallies are not symmetrical
Defaults come mostly because of cash flow, not character
The three Cs that determine credit quality are cash flow, collateral (or assets) and character. The first two are easy to measure; the third is much more amorphous. And yet it matters, as credit investors who suffered through Enron, Parmalat or Wirecard will know.
New issue markets are making credit indices more risky
As of mid-November, overall primary supply this year has not quite reached the total of 2019 – but it has come close. The most interesting thing about supply this year was not the total amount, but the mix. After closing in late February and March due to COVID-19 fears, the investment grade reopened with a fury, and a record €230bn was sold in just four months before a slowdown in 2H20. The move was reminiscent of 2009, when issuance doubled from previous levels.
Chart 5 also shows the dispersion in NIPS, with some issuers paying 80bp over their secondary issues.
As Chart 6 shows, senior bank supply may end the year at just three quarters of 2019’s total.
Chart 7 shows how three historically large sectors – telecoms, autos and utilities – have all fallen from their peaks. Telecoms have dropped most precipitously (due to ratings changes as well as changes in funding patterns), but autos and utilities are also lower.
Compare this with Chart 8, which shows that the industrial, tech and healthcare and oil and materials sectors have all got significantly bigger.
WhAT TO EXPECT in 2021?
Since then the credit cycle has become shorter. Investors no longer enjoy long periods during which they can simply accumulate carry, since bear markets now follow immediately on the heels of bull markets. In previous research, our analysts have said that the credit cycle has become a credit spiral. Yet this does not mean that bear markets and bull markets are symmetrical.
This year has offered a reminder that most defaults have nothing to do with character. Instead, cash flow is what matters most.
Issuance this year also confirmed a number of longer-term trends discussed previously. The more important trend is in the industrial make-up of the index. Financials have declined from their 2008 peak when they were 54% of the index, but at 39%, they are still the biggest part of the index. The more important change has taken place in non-financials: three historically large sectors – telecoms, autos and utilities – have all fallen from their peaks.
Balance sheet leverage is at historical highs, the economic outlook will be uncertain even after a COVID-19 vaccine arrives, and European governments are preventing the kind of short, sharp default cycle that would purge the market of credits with the wrong business models or too much leverage. Investors waiting for those ‘zombies’ to disappear may feel like bored opera-goers, wondering why the soprano won’t sing for a while.
Widening is faster than the tightening
Primary market second busiest year ever
IG issuance 2009 record took seven years to beat
By continuing to use our website, you are accepting our use of cookies. The cookies we use are "analytical" cookies. They allow us to recognise and count the number of visitors and to see how visitors move around the site when they are using it. To find out more or to change your cookie preferences, please refer to our cookies policy.
ACCEPT
#contentwithimpact
Contact
This page contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale, at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for use by institutional and professional investors and is not intended for retail investors. Investors should consider this report as only a single factor in making their investment decision.
© Societe Generale 2020
Cookies Policy
Legal Information
Source: SG Cross Asset Research. As of November 2020.