Overview of global credit performance in Q1 2020

Global credit performed negatively in Q1, heavily impacted by the novel coronavirus (COVID-19) pandemic and the worldwide lockdowns that resulted in outflows from credit markets. Global credit markets started the year very strong, with spreads tightening across all rating classes and all parts of the capital structure. The market was approaching pre-Global Financial Crisis (GFC) spread levels, when the rally came to a sudden stop as COVID-19 swept across the globe and led to lockdowns of entire economies. Since then, the markets have priced in a prolonged recession and spreads temporarily came close to post-GFC levels.

Prior to the COVID-19 pandemic, we had a strong preference for defensive sectors with a focus on infrastructure, which we felt had structural advantages. The demand shock triggered by measures undertaken to limit the pandemic has only confirmed these views. Cable & telecom, gas and electric utilities, healthcare and technology sectors have the most defensible cash flows to maintain their balance sheets throughout the crisis. For sectors with greater exposure, such as retail, automotive and consumer discretionary, our focus is limited to the large, well-capitalized firms with enough liquidity to withstand 3–9 months of a significant drop in operating revenues. Energy remains a primary concern, as the global drop in demand, combined with a breakdown in production discipline from major global oil producers, has created an unsustainable operating environment for all but the largest of integrated energy firms.

In Q1 we kept our focus on non-cyclical credits, i.e. telecommunications and utilities, and stayed more cautious on others, i.e. automotive and energy. We continue to have a favourable view of CDS relative to bonds, given the superior liquidity of the former.

Outlook for Q2 2020

At this juncture, it is difficult to determine when global economies are going to reopen and when the epidemic curves will flatten. Rather, we see more value in analysing known facts instead of speculating about the future. The known facts are mostly found in market technicals. Global central banks are currently giving massive support to credit markets through different bond purchase programs; the Federal Reserve, for example, has even opted to buy high yield bonds. In addition, government support is also visible in most economies in the form of guarantees and unemployment schemes. We think that such monetary and fiscal support, combined with attractive market valuations, provides an attractive entry point for investors. That said, we also think sector allocation as well as bond selection will be crucial factors during the recovery stage.

We are uncertain how long the economic restrictions to battle the pandemic will last, but we also place a high degree of confidence in central bank support and fiscal stimulus. Exposed sectors may appear attractive. But we do not have a favourable view of such sectors as the decline in demand and potential cultural changes following the pandemic could permanently alter consumer demand for certain industries.