Global credit markets have reacted to the Coronavirus crisis with force: Credit spreads have swung from well below to well above long term averages in a matter of weeks, raising concerns about increasing debt levels in a recessionary environment, but also creating opportunities for the prudent and patient investor. In this Q&A, portfolio managers Eve Tournier and Sonali Pier share their interpretation of recent market moves, and their views on what parts of the market investors should pay attention to - and which to avoid.
Q: What were your thoughts about valuation levels towards the end of last year, when market optimism was high?
Eve Tournier: We have always favoured diversification, as that is one of the best ways to help protect investors from unexpected shocks and add resilience to portfolios. At the beginning of this year, optimism seemed to fuel markets, taking valuations to levels that we felt, in many cases, did not allow any room for disappointment. We obviously did not anticipate this black swan event, but the extreme optimism made us cautious.
Q: How have your views changed given the new environment?
Sonali Pier: Our preference for quality, caution and diversification has not changed but valuations have.
We find that the investment-grade and asset-backed security sectors provide an attractive liquidity premium, which can help compensate for the increased volatility and uncertainty.
On the other-hand, we remain prudent on high yield and emerging markets given the increased vulnerabilities and default risk. Careful sector and individual security selection is critical to finding opportunities in those markets.
We continue to be cautious on cyclical sectors and those most exposed to the crisis while favouring traditionally resilient sectors, such as telecom/cable and utilities. Pharmaceuticals and healthcare is another sector that is traditionally defensive and that could also see increased sector earnings due to this crisis. Some banks are also attractive, given their much-improved balance sheets and capital buffers brought on by tighter regulation, which makes them well equipped to deal with the impacts of a recession.
Q: Which sectors could be most affected by the recession?
Tournier: The energy sector is clearly vulnerable right now. Going into the crisis oil companies were already suffering from excess supply; it has now been compounded with an exceptional demand shock. Ongoing uncertainties around when lockdown measures will be fully lifted, the future of airline travel and a more remote-based working environment all contribute to the uncertain trajectory of oil prices.
Away from energy, other sectors such as non-food retail and leisure will face pressure depending on the duration of social distancing measures and the impact of the crisis on consumer demand. All this could lead to an escalation of defaults, although many issuers have liquidity and bank lines or other measures they can take to help avoid default in the near term.
Finally, automobile and airline companies are also heavily impacted and the inter-play of exceptional government support needs to be carefully integrated in the analysis. Bottom-up security selection has never been more important.
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