High-yields in the credit market would be 'the canary in the coal mine': Strategist

Invesco Global Market Strategist Brian Levitt sits down with Yahoo Finance Live to talk about the market outlook on high-yield bonds, how investors should position themselves amid rising inflation and volatile markets, and whether Fed interest rate hikes align with international recession concerns.

Video Transcript

SEANA SMITH: All right, let's talk a little bit more about the action we're seeing, not only in the bond market, but also in the equity market, because all three of the major averages lower still, with just about 45 minutes to go in the trading day. The move in the Dow that you're seeing, down 377 points, led lower by losses in Apple and Intel.

Here to talk more about that, Brian Levitt. He's Invesco global market strategist. And Brian, it's great to see you again. We got this pretty strong report coming out, 390,000 jobs added to the US economy in May. Markets, not really sure how they feel about it. How are you looking at this report?

BRIAN LEVITT: Yeah, it's a strong report. I mean it's indicative of an economy that still has good strength. Now employment is going to be a lagging indicator. So we don't want to take too much solace in it. I was pleased to see that average hourly earnings did not increase beyond expectation. I do continue to believe that inflationary pressures will start to come down.

But rates adjusted as a result of a strong rapport, longer duration assets. Look, particularly, NASDAQ stocks sold off. And that's sort of been the case this year, where things can come in a little bit too hot, rates move higher, and investors take out the names that had performed very well in what was a low interest rate environment and no longer is.

JARED BLIKRE: Brian, I want to get your comment on something that really caught my attention this week. And that was S&P Global suspending their annual guidance and saying that the economic conditions are deteriorating and are, quote, "extraordinarily weak." And this is talking about the debt market. Is the corporate bond market in trouble here?

BRIAN LEVITT: Actually, no, and if you've looked at spreads through this environment, actually, high yield bond spreads have been pretty stable. In fact, they were widening maybe a month ago a bit, but they've actually come back in. And so that's a testament to the fundamental strength of corporate America. Now, you'll find parts of the bond market, like CCC, high yield, where spreads have widened out.

And sure, in an economic slowdown, there will be some companies hit there. When the tide goes out, you see who's swimming without a bathing suit, as they say. But in aggregate, what you found there on corporate America is that most took advantage of a very low interest rate environment, pushed out maturities.

And companies are in reasonably good shape if you look at most leverage ratios and if you look at most interest coverage ratio. Now, if we start to see high yield and other parts of the credit market break down, that is the canary in the coal mine, right? That's end of cycle stuff. So far, that really hasn't been the case.

SEANA SMITH: Brian, I think a lot of investors out there trying to figure out what to do right now. There's so much uncertainty. We have seen unprecedented volatility, or the most volatility, really, that we have seen some of these large single-day drops over the last six or seven weeks. I know you were looking into what would have happened if an investor pulled $1,000 out of the market after each of the last worst 54 days since 1995 versus putting money to work. What did you find, and what can investors learn from that?

BRIAN LEVITT: Yeah, what you find if you look at the 54 worst days, and I chose 54 because a few weeks ago, we had the 54th worst day, you're actually better off adding that day, rather than taking money out of the market. It's the old classic time in the market, not trying to time the market argument. In fact, the other thing that I like to point out, if you look at the 15 best days over the last 25 years, 100% of them happened during crisis environments, whether it was the tech wreck, the financial crisis, or the COVID outbreak.

So investors have a tendency to want to pull money out and often end up doing so at inopportune times. In essence, what you're hoping for this summer is signs that the economy is slowing, more signs that inflation has peaked, and that should provide-- start to provide some comfort to this market.

JARED BLIKRE: Yeah, very important point there that the best days in the market often come right next to the worst days. And those are at the lows. I want to shift gears and pull up the YFi Interactive here. I have the US Dollar Index, and this is a 10-year chart. You can see, we've just bumped up against a potential resistance area here. I'm not drawing it very well. That's right around 102, 104, let's call that. You take a look at the longer term. Here's a max chart. Wow. It looks like the next resistance level is 120 that we hit, what, in 2000, 2001? What happens if we head higher like that?

BRIAN LEVITT: Yeah, if you had higher, it's a clear sign of flight from other parts of the world. It's a risk-off environment. And what's driving that is, one, yield differentials between the US and a lot of the rest of the world have now narrowed, and, two, policy in the United States is likely to be tighter. And so the way investors should think about how this plays out, I mean, the way all cycles play out is, it first starts with high and rising inflation, then a flatter yield curve, credit spreads moving out, and strength in the dollar.

So I would categorize what we're looking at as risk to the cycle. I mean, you can't sugarcoat it. Inflation and tightening and what's happening in the dollar suggest that there's risk to the cycle. But nonetheless, if you look at the way the market has been behaving with value stocks outperforming, commodities up, interest rates moving higher, the market's not behaving as if-- and even high yield spreads, as we talk about.

The market's not behaving as if a recession is imminent. If anything, what you're seeing in markets is an adjustment in valuations as a result of the higher interest rates. So we're not ready to say this cycle is over. Sure, the risks are elevated. Sure, the economy is going to slow. To me, that means a more neutral risk profile relative to a benchmark, compared to where you are in the recovery and expansion phase of this cycle where you wanted to be full risk-on relative to a benchmark.

SEANA SMITH: So, Brian, with that in mind, if you're being a bit cautious, you're not fully risk-on at this point, what are you favoring? What are some of the top sectors or where you're seeing the most opportunity today?

BRIAN LEVITT: Well, the first thing I would say is, nobody wants to be in long duration government bonds right now. And I think that that's a mistake. I know that there was the worst pain we've seen in years in the bond market as rates adjusted, but that's the ballast in the portfolio. So I would be mindful about selling core government-related, municipal bond-related bond exposure right now, particularly the government bond-related parts of the market. You're going to want that exposure if the economy rolls over.

Within the equity markets, it's what's been doing well. I mean, you want to be a bit more defensive. You want to pay more attention to value. You want to have higher quality in your portfolio and historically lower volatility stocks. Again, it's, when you're recovering or when you're expanding that you want to be risk-on in the portfolio. And we're not in that place right now, unfortunately.

SEANA SMITH: All right, Brian Levitt, always great to speak with you. Thanks so much for taking the time to join us.