We talk often/always/incessantly about “cycles”. Market cycles are driven by the broad availability and cost of money. Market cycles are driven by economic growth and contraction. They are driven by innovation, investment, corporate earnings, employment, and credit availability. Market cycles are like the ocean tide: they go both in and out, sometimes with force.
If corporate earnings are what drives the equity market over time, it is lending standards that drive the direction and scale of credit defaults. Credit defaults = permanent loss, not temporary price impairment. When lending standards start getting tight, bond defaults start to appear in the high yield bond market about 6-12 months later. Financial conditions tightened dramatically during 2022 and lending standards have gotten a lot tougher. Tighter lending standards in 2022 will translate into a rising level of HY bond defaults in 2023. It’s not a question of “if” they go higher; it’s only a matter of “when”. The equity market had its volatility and recession in 2022. The high yield credit market will have its defaults during the recession of 2023.
In our mind high yield bonds and low-quality credit remain an area to avoid. We will continue to do so until defaults pick up and HY prices fall A LOT. That is likely a 2H23 event.
Richard Barrett
Chief Investment Officer
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