Risk Markets get a Shot in the Arm

December 3, 2020

Source: Bloomberg Barclays High Yield and Corporate Index; As of November 27, 2020 Source: Bloomberg Barclays High Yield and Corporate Index; As of November 27, 2020

As we close one of the most anxiety-ridden years both personally and professionally, the world received great news with the Pfizer and Moderna vaccine efficacy data in early November. It appears that widespread distribution will be achieved by next summer and despite what will be a very difficult winter, springtime promises to be the beginning of a new and powerful business cycle. Debt and equity markets have responded accordingly and are increasingly pricing in this possibility.  

Prior to the vaccine news, markets were buoyed with a relatively orderly presidential election and the expectation that a Democratic president and Republican Senate would produce only incremental policy changes. A stable political environment, coupled with likely fiscal stimulus and continued accommodative monetary policy, started another rally in credit spreads and equities in November, as seen in this week’s chart. While I agree with the market reaction, it is the promise of multiple safe and effective vaccines that really makes me bullish heading into 2021.   

Valuations reflect this optimism, with investment-grade and high-yield spreads about 20 basis points and 100 basis points, respectively, away from levels at the beginning of the year. Still, with default rates and downgrade activity moderating, corporate profitability improving and liquidity ample, I anticipate further spread tightening. In fact, if the vaccines prove to be as effective as advertised, the psychological boost to sentiment and ultimately economic activity will be tremendous. Also, I think we will hit post-crisis spread tightening as we close out next year. If this materializes, Treasury rates are also likely to rise and put a damper on overall total returns, with the high yield asset class as a relative outperformer. 

Key Takeaway

The last seven months have felt like a lifetime and the next few months will be very challenging, particularly for those hardest hit by the pandemic. While things may seem grim as infection rates go up, new restrictions are imposed and the political transition remains uncertain, I would add risk to position for better days. Hope is not an investment strategy, but under the current circumstances, it goes hand-in-hand with my constructive outlook for corporate credit spreads.

Tags: Risk Markets | Credit spreads | Equities | Treasury rates | Coronavirus

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The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.

This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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