U.S. Growth Puts Credit in the Sweet Spot

U.S. Growth Puts Credit in the Sweet Spot

PIMCO believes this is a particularly opportune time to move into higher-quality credit, as well as select high yield and bank loan sectors.

Credit continues to look attractive in today’s growth environment, where we expect real U.S. GDP growth of 1.75%–2.25% in 2016. This chart shows the historical credit spread (yield differential over U.S. Treasuries) at varying real GDP growth rates. In a 1%–3% growth environment, like we have now, average credit spreads have been around 200 basis points.

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Given that historical context, investors can see that the growth outlook supports current credit valuations (red dot), and should help to keep defaults low. Valuations are also backed by the solid and stable fundamentals of most corporate issuers, in addition to market technicals that should increasingly favor capital flows into high quality U.S. credit assets. Importantly, at these levels, the yields on investment grade credit and select high yield credit look attractive relative to the free cash flow yield on U.S. equity. Both yield measures are an indication of potential return, but credit has shown significantly less volatility than equity (annualized standard deviation of 4.1% for the Barclays U.S. Credit Index and 10.5% for the Barclays High Yield Index versus 15.0% for the S&P 500 for the trailing 10 years ending 31 March 2016).

Investors trapped in a low or negative yielding asset class may be tempted to move toward riskier assets like equities. Instead, consider credit as a risk-adjusted alternative, offering the potential for near equity-like returns with a fraction of the volatility.

For more analysis of trends shaping the economic outlook and their investment implications, please read the latest Putting Markets in Perspective.

DISCLOSURES

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy. There is no assurance that the liquidation of any collateral from a secured bank loan would satisfy the borrower’s obligation, or that such collateral could be liquidated. It is not possible to invest directly in an unmanaged index. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.