Post Covid-19, investors are more comfortable with debt, banks are the solution rather than the villains of 2008 and markets will have bouts of euphoria and despair.
These are the predictions of fixed income investors Paul Nicholson and Gregory Peters speaking at Investment Magazine’s Fixed Income and Credit Forum in late March.
Peters, managing director and head of multi-sector & strategy at PGIM Fixed Income, says unprecedented Central Bank activity in response to the Pandemic has “changed the game” as well as the risk and reward as a credit investor.
“Basically the world is more comfortable with leverage and companies have been allowed to refinance their debt at a lower cost of capital,’’ Peters says.
“(They’ve) added debt but replaced higher cost debt so it’s been a weird situation where companies have been allowed to get new debt on their books but replaced more costly, older debt. It’s been a balance sheet repair event by allowing companies to refinance, add liquidity and take down their cost of capital.”
Nicholson, global fixed income director at QIC, sees a long-term trend of sovereign debt “crowding out” corporate debt allowing corporates to behave better and reduce leverage.
“If I look down the road 3-5 years, I look at the tremendous amount of sovereign supply hitting the global bond market and what happens in that situation is that actually creates a stronger demand for corporate credit as corporate credit, going forward, will be crowded out by the sovereign need,’’ Nicholson says.
“Whether it’s 2021 or 2022, I think the CEOs and boards will move to more equity friendly activities versus the balance sheet repair. Animal spirits will come back and that’s definitely part of the second half of 2021 as we go into this V-shaped recovery in Europe and the US.
“I do think that the comfort of leverage will seep into the corporate market”.
Nicholson says fixed income investors will need to be active, pragmatic and mindful of how markets can change in response to unprecedented events like the Pandemic.
“Coming into 2020 we were very careful. We thought that the US was slowing and, beyond that, we actually thought that financial markets and valuations were priced to protect the near growth path,’’ he says.
“It didn’t work out according to plan last year. Generally those fundamentals will play out and I think that this discernibility of credit selectors will remain ever beneficial to investors because there will be winners and losers no matter what. That’s the nature of the beast.
Peters draws differences between the markets’ response to the Global Financial Crisis (GFC) and the Pandemic.
“In 2008 the banks were the villains. There is no villain today so, as a consequence of that, the cycle is more compressed,’’ he says.
“What I learned during this crisis is that companies were much more adaptable than we initially thought by allowing their workforce to be scattered and work remotely, retailers could turn online platforms in such a swift way that it will help their profit margins going forward in a way that we didn’t initially suspect.