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Goldman Sachs Has a Point on Credit Recovery, But Be Very Careful

Marcus Ashworth
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Goldman Sachs Has a Point on Credit Recovery, But Be Very Careful

(Bloomberg Opinion) -- With $250 billion of new U.S. bond issues at investment grade since the middle of March, and 150 billion euros ($164 billion) in Europe, the high-end credit market is an undoubted beneficiary of the central banks’ coronavirus stimulus plans. The debt capital market is definitely back open.

Indeed, analysts at Goldman Sachs Group Inc. have bravely ventured that the worst of the widening of credit spreads — where the yield on corporate debt starts to increase faster than that of benchmark bonds — may be over for high-grade issuers.

As I’ve written before, it’s important not to see this as a sign that all is well in the entirety of the credit markets: Companies with non-investment grade paper are crucial to the real economy too, but junk bonds are a long way from being in a good place. Defaults are looming.

Setting aside the broader economic concerns of this state of affairs, there will be opportunities for investors in finding companies that will emerge from the crisis stronger — or the ones that will get most state support, if you’d prefer to be cynical. Credit selection, akin to stock-picking, will be the answer for those hunting yield. Tread carefully among the rubble and you might find some sparklers.

As the Goldman analysts say, the high-grade part of the market is functioning well. There are 16 new issues slated in the euro debt capital markets on Thursday, including bonds from corporate giants such as BP Plc, British American Tobacco Plc and Royal Dutch Shell Plc. There’s even a rare deal coming in sterling, a market that’s been largely shut, from carmaker Volkswagen AG. That will be a significant test for a sector that’s been effectively shutdown by Covid-19.

Credit spreads blew out spectacularly in March, and while things have improved, the environment has changed profoundly — even for the higher quality stuff. The premium offered on yields for new issues and overall credit spreads are significantly wider than during the first two months of this year, before the coronavirus struck the West in earnest. 

For corporate issuers, the heady days of rock-bottom interest rates are over, but this is better news for investors. The potential for positive performance is phenomenal, explaining why so many are diving back in to try to outperform the index. The European Central Bank has 1 trillion euros of bond purchases to complete this year, with as much as 20% of that to steer into eligible investment grade companies. That will be a major tailwind for a spike in the value of corporate debt.

The ECB excludes financial firms and junk bonds from its Quantitative Easing program, but the crowded demand for high-quality paper will no doubt steer people toward non-investment grade sales, helping issuers. Also, whisper it, but the eligibility criteria for QE might well be softened.

High-yield is still suffering badly from blown-out credit spreads. But it can offer the biggest opportunities to investors, especially if the particular company is critical to any economic recovery. Government credit and bailout plans might add to the appeal of certain sectors such as infrastructure, health and utilities. 

Less vital industries in the junk bond space will have to pay up to attract buyers. The beleaguered cruise liner company Carnival Corp had to pay a whopping 11.5% coupon to raise $4 billion this week. To get a sense of how far things have gone south for Carnival, at the beginning of March the yield on its existing three-year dollar bond had slipped below 2%. 

Bank debt might be popular too. Lenders’ senior investment-grade paper is already practically backstopped by national central banks. Subordinated bank debt remains for the brave, albeit the riskiest additional tier-1 perpetuals (known as CoCos, where investors lose out if a company goes bust) will always have their fans among those clamoring for proper yield. 

Selecting which companies can weather a crisis versus the dead ducks has probably been the most overlooked financial skill-set since the Lehman Brothers crisis, especially in corporate bonds. Blanket QE and the remorseless rise of passive investing has masked what active managers should be best at. It will pay in future to invest in a more selective fashion rather than simply buying the index.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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