The bullish case:
Earnings have been pretty strong from a base of high expectations coming into 2021. For example, of the 489 S&P 500 companies that have reported quarterly earnings for the first quarter of 2021, there was a 23% aggregate earnings surprise. Of the companies that had reported, negatively. Overall, S&P 500 companies showed earnings growth of over 48%, year-on-year.
Balance sheets in general are in decent shape. Net leverage for investment-grade bonds is below where it was before Covid-19. Although high-yield leverage is currently still quite high, it is set to drop because of expectations of strong earnings growth. We expect companies’ interest coverage to increase to close to a record high. This should provide a cushion against rising rates.
Corporate default rates are expected to peak at a low level. Moody’s says the global high-yield default rate is likely to have peaked at only 6.8% in December 2020. In previous recessionary cycles it has tended to peak at between 10 to 13%.
The bearish case:
Default rates are low because of huge central bank and government support. However, this has to be unwound at some point.
On the consumer side, although default rates for mortgages are low, this is because of payment holidays and income from temporary furlough schemes. There have been requests for payment holidays in many different countries, which have had varying levels of regulatory support. In any case, furlough schemes and payment holidays will eventually have to end and the true level of arrears and defaults will become apparent then.
Recovery rates during the Covid-19 crisis have been low. The rate is 45 cents on the dollar for loans and bonds, according to US statistics from Moody’s, compared with 59 cents in 2008–9. For loans only, the rate is just under 50 cents, compared with 70 cents in 2008–9. Some of that is due to doc-lite, some of it is due to corporate structures and some to the capital structure underneath the loans – albeit a mix which has so far led to fewer defaults than expected.