In our view, we don’t think a material pullback is likely in these reopening sectors, but should we experience another market panic similar to that of March 2020, we would view it as another compelling buying opportunity. This conviction is premised on the fact that global vaccination rates are markedly higher versus a year ago (which goes a long way to mitigating material spikes in hospitalisation and mortality rates) as well as on the resolve of policymakers and central bankers globally who have yet to remove the aggressive accommodation currently in place. If anything, their rhetoric suggests they will remain highly vigilant to prevent downside growth risks. Both of these macro-level factors temper our concern that we might see widespread lockdowns that threaten to derail the pace of the global economic reopening.
At a micro-level, it bears repeating that with the help of emergency response programs, such as the Federal Reserve’s Primary and Secondary Market Corporate Credit Facilities, companies (in many cases) have adjusted their business models to compete and survive in a post-pandemic reality. Many have significantly fortified their balance sheets by refinancing and extending near-term debt.
This helps explain the continued resilience of corporate credit fundamentals, specifically the sharp decline in default expectations and the uptick in the upgrades-to-downgrades ratio observed in the US high-yield complex. Delta Air Lines is an example of one such issuer whose bonds experienced a significant amount of stress during the height of the pandemic, but have since bounced back sharply due to a rebound in business travel and customer acquisition, but also in large part due to active liquidity management. Case in point, after reporting strong Q2 earnings, the airline announced that it would use $1 billion of its accumulated $15.2 billion cash balance to tender for high coupon debt that was issued in 2020.
After COVID-19’s asteroid-like impact on global financial markets last year, we’ve been wary of the possibility that one of the many COVID-19 variants making the rounds globally might take hold and rekindle the market panic we experienced in 2020. The behaviour of the US rate market year-to-date continues to reaffirm our long-held view that US Treasuries remain among the best diversifying hedges against spread risk in broad market and multi-asset credit portfolios.
For now, we maintain our constructive stance on corporate credit due to favourable fundamentals and supply-demand technicals, and continue to position for a reopening trade. We favour certain cyclical sectors including airlines, cruise lines and select retail segments complemented by a higher-quality bias in less cyclical subsectors that provide ballast in portfolios. Should we see a resurgence of market fear that leads to a material widening in credit spreads, we may then favour issuers offering solid income and total return potential.
Robert Abad, portfolio manager, Western Asset, part of Franklin Templeton