As markets normalise, valuations are supporting a higher allocation to high-yield credit. This is in part due to increased savings and the involvement of central banks in fixed-income markets, which has boosted flows into spread products. Within high yield, strong valuations and fundamentals mean that the BB-rated segment looks the most attractive from a top-down perspective (see figure 1).
Figure 1. BB-rated credit looks appealing
Source: ICE Bond Indices, Federated Hermes, as at July 2020.
Earnings season should also pick up steam this week, as investors anticipate more information on full-year earnings expectations and how business models can adapt to the post-coronavirus world.
Like last quarter, we are likely to see increased dispersion as higher-rated companies are better able to preserve cash by cost cutting and reducing shareholder distributions. While there should be a small uptick in downgrades in response to weaker earnings, the magnitude of downgrades recorded year-to-date mean the volume should be underwhelming.
