The global economy is flagging. The US-China trade war has pushed down Purchasing Managers’ Index readings and fragile fundamentals have depressed earnings across sectors, many of which also face structural challenges. This has limited access to capital for issuers that have more uncertain outlooks and do not have the levers to respond to increased external volatility.
Because of this, the distress ratio – one of the measures used to forecast future defaults and expected volatility – remains elevated across the global high-yield market. Figure 1 shows how distress ratios have risen in the US, Europe and emerging markets over the past three years.
Figure 1: Distress ratios rise
Source: Herme Credit, ICE bond indices, as at December 2019.
A lower distress ratio in Europe can be explained in part by the fact that it has less exposure to the energy and pharmaceutical industries, which have both faced challenges this year. Credit quality is also higher on average in Europe, with CCC-rated instruments making up a much smaller part of the market. In addition, there has been stronger demand for high yield ever since the Corporate Sector Purchase Programme restarted.
Conversely, a slightly higher distress ratio in emerging markets can be explained by turmoil in countries like Argentina. Moreover, emerging-market high yield tends to trade 150bps wider than US high yield.
Next year will likely see a heightened focus on fundamentals, meaning that bottom-up research and the ability to take a top-down view of global credit markets will be as important as they have been over the last 18 months. To hear more about our outlook for credit markets in 2020, listen to our Delta podcast.