BlackRock came down hard on the side of credit this week, citing improved valuations, strong balance sheets, low supply and moderate refinancing risks.
“We prefer investment grade (IG) credit over equities on a tactical horizon as we see a new market regime with higher volatility taking shape,” said the firm in a research note. “We believe IG credit can weather a significant growth slowdown whereas equities don’t look priced for this risk.”
Since June, markets have been captivated by the prospect of lower rates in the face of a growth slowdown, BlackRock analysts including global chief investment strategist Wei Li explained. “This has resulted in a drop in yields, boosting IG performance and triggering a 10%-plus equities rally. We still like IG credit at these levels.”
“We believe IG credit can weather a significant growth slowdown whereas equities don’t look priced for this risk.”
The asset manager believes that credit yields now look more attractive than they did at the start of the year, due to a surge in government bond yields and a widening of spreads (the risk premium investors pay to hold investment grade corporate bonds over treasury paper).
“We think higher coupon income provides a cushion against another yield spike as markets price in the persistent inflation we expect. Equity valuations, meanwhile, don’t reflect the chance of a significant slowdown yet, so earnings estimates are still optimistic, in our view,” said the analysts.
Trends in the corporate bond market would appear to support this outlook. Supply is relatively low, with corporate bond issuance down almost 20% this year according to S&P data, and many issuers waiting to see what happens in the market before issuing further debt. Refinancing needs are also not too pressing, due to the surge in issuance over 2021 – with issuance levels of around $1 trillion comfortably exceeding expected annual upcoming maturities of under $600 million up to 2029.
“We see IG credit weathering a slowdown better than stocks. We see activity stalling, underpinning our underweight to most developed market equities,” concluded BlackRock. “When would we turn positive on equities again? Our signpost is a dovish pivot by central banks when faced with a big growth slowdown, a definite sign they will live with inflation.”