The weakness that investors expected at the end of 2019 – haunted by memories of the shakeout the year before – has finally hit markets. The longest bull run in history and challenging valuations created the perfect storm for a market repricing last week.
The high-yield market recorded the largest weekly drop since 2011, as the spread of the coronavirus sparked fears about the health of the global economy. Looking at different parts of the credit market in more detail, developments were much as expected: cyclicals underperformed, as commodities remained under pressure from an oil price that is down nearly 20% from recent highs.
Nonetheless, there are some interesting areas worth examining. First, BB-rated credits have significantly underperformed those rated BBB: the spread difference has reached 2.1x (see figure 1) which is a multi-year high.
Figure 1. Credit market moves after a week of turmoil
Source: Federated Hermes, as at January 2020.
This is largely because BBB-rated credits are benefiting from the large stock of negative-yielding assets and the resulting reach for yield, while those rated BB are suffering because of higher liquidity (in comparison to the rest of the market) which means they are being used to manage outflows and raise cash.
Emerging markets are also outperforming both over the week and year-to-date, which suggests that the market has developed over the past 5-10 years. It is now worth more than $1.5trn, as investors increasingly realise that emerging-market crises have become more contained over the past 10-20 years.
Finally, CCC-rated credits have also performed well on a beta-adjusted basis as the market remains largely driven by underlying idiosyncratic dynamics. A lack of significant dispersion between lower and higher-quality credit confirms that the market is focusing more on cyclicality, and less on the widespread pick-up in defaults that could result from the current supply-and-demand shock facing markets.