Credit update December 2, 2013

The week of Thanksgiving passed smoothly although a four-nation sabre rattling has increased in the East China Seas, but well countered recently by the wave of optimism (and lower oil prices) with the Iranian nuclear negotiations.

For 2014, I expect equities to lead the way as it did in 2013 but with a slowing wake. While the economy recovers, and per capita income improves, net revenue growth will once again be a struggle and therefore, the emphasis on cost-cutting and profit margins will continue, aided by equity buybacks and (less of) dividend payments fueled by cheap debt. The QE taper when it happens, may rock the boat temporarily but will shift momentum to growth vs. value. In credit, even with no taper, high yield at the 5.6% area will be hard-pressed to make more in total return (in 2013, YTD returns are 6.7%). But high yield is still the best-positioned within credit for incremental return – with or without taper – with spreads at 420 bps or so (at the lows for the year) and default rates at lows and expected to stay low. Many yield-hungry fixed-income-only participants have increased allocations in high yield for that very reason, taking up the space vacated by multi-asset total-return fleers who have moved to distressed and/or equities.

The same positive case for returns will be difficult to make for investment-grade as a sector play and the game had best be played on a name basis (or bottom-up selection). With skinny spreads (+135 bps) and yields (3.4%) not much above the US Treasury 10-year (2.75%), the risk from a QE taper is all that much greater.


Investment grade +69 bps over swaps (unchanged week over week)

High yield – 5.6% yield to worst (unchanged week over week)


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