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.
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.