Global Credit Perspectives

Credit Markets Still Supported By Global Trends

Even after this year’s rally, credit remains one of the more appealing sources of income in financial markets.

For investors, the search for yield and strong appetite for income are complicated by the reality that roughly $12 trillion in bonds in the Barclays Global Aggregate Index are now at negative yields, including more than 75% of Japanese and German government bonds (see Figure 1). The European Central Bank, the Bank of Japan (BOJ) and, lately, the Bank of England are continuing with unconventional policies, including large-scale asset purchases and suppressing interest rates, even as the BOJ last month seemingly acknowledged that such policies were hitting the limit.

Figure 1 is a bar graph showing the negative yielding market value of the Barclays Global Aggregate Bond Index in December of 2015 and July 2016. The first bar shows $3.7 trillion in negative yielding market value on 31 December 2015. By contrast, a much taller second bar shows the value at $12.1 trillion on 31 July 2016.

Consequently, in a world of low- and negative-yielding government bonds, investors are allocating more outside of their domestic markets, creating a wave of investment into global credit markets. This has continued to support credit markets from a technical perspective, with more demand for bonds relative to supply.

Even after this year’s rally, credit remains one of the more appealing sources of income in financial markets. We believe investors can still seek potential returns of 3%–6% in the credit markets by investing in investment grade and select high yield corporate bonds, bank loans, emerging markets and non-agency mortgages. At these levels, credit is especially attractive as an alternative to high concentrations in government bonds. The technical demand for higher quality credit may increase given the decline in government bond yields this year, while fundamentals and valuations also remain supportive, especially for U.S.-focused companies with growth potential and the ability to raise prices, as well as for select emerging market companies.


Credit fundamentals are really a function of how well the economy is doing. Among major developed markets, Japan and Europe are barely growing, but the U.S. should be able to achieve real GDP growth near 2% over the coming year. With inflation near 2%, that means almost 4% nominal GDP growth, which will likely keep default risk low.

Over the last year or so, credit market leverage has increased due to mergers and acquisitions and declining profits, especially in commodity-producing industries, but there are reasons to be constructive. If you look at what drives growth in the U.S., the consumer is roughly 70% of the economy and is well positioned to continue to spend and boost total economic activity over the next year. Over the last 12 months, the U.S. private sector has added 2.5 million jobs, incomes and wealth have risen and access to credit has improved. Over the next 12 months, a recession in the U.S. remains unlikely as there are few imbalances in the economy, and accommodative central bank policy should help extend the duration of this economic and credit cycle.

These positive fundamental factors, combined with a solid U.S. banking sector, relatively low borrowing rates and a reasonably confident consumer outlook, help explain consumers’ willingness and ability to spend on the goods and services produced by companies.


There is huge demand around the world for high quality income-producing assets, and credit markets can offer that income. While high quality credit is riskier than government bonds, it has typically had only one-third the volatility of equities, and the investment opportunity is more scalable relative to other credit market opportunities: The corporate bond market exceeds $6 trillion in the U.S. alone, and issuance this year is likely to exceed $1 trillion. Globally, the market for government bonds is nearly $30 trillion, but with an average yield of less than 1% (about 60 basis points).

With $12 trillion of negative-yielding global debt weighing on the overall market yield, we anticipate investors will continue to seek higher-income-producing securities and reduce low- or negative-yielding exposure. Because high quality credit continues to hold higher correlations to government bond returns than below-investment-grade credit, allocations to this sector can still offer diversification from equity market risk. Indeed, given their higher yields, portfolio diversification benefits and scalability, we continue to expect allocations will increase to investment grade credit at the expense of government bonds.

Figure 2 is a bar graph showing yield to worst of various bond classes and their total market value as of July 2016. Yield is expressed on the Y-axis, and market value on the X-axis. Global Treasuries have a market value of $35 trillion, much more than any other fixed-income asset class, and their yield was less than 0.5%. This is expressed as a long horizontal bar extending across the bottom of the graph. By contrast, U.S. high yield bonds show a yield of almost 7%, but have a relatively small market value, so this asset class is represented by a tall, thin, vertical bar on the left of the graph. Emerging markets are similar, with a yield around 4.5% and slightly more market value, shown by a shorter bar. U.S. investment grade has a yield around 2.5%, with a market value of about $10 billion, with its bar taking the shape of a square. Index proxies for each asset class are detailed below the chart.


Even amid the huge demand around the world for high quality income-producing assets, credit spreads remain a little wider than their historical average relationship, based on fundamentals – and it is worth noting that few financial assets are near their historical average price multiples or spreads. While credit spreads are not as high as they were in February after the broad market drop at the beginning of 2016, they remain relatively attractive (see Figure 3): BBB rated corporate bond spreads have declined about 30 bps year-to-date, but five- to 10-year maturity U.S. Treasury yields have declined about 80 bps.

Figure 3 is a bar graph that shows credit spread ranges versus real GDP year-over-year growth as of 30 June 2016. Spreads are represented on the Y-axis, and real GDP growth on the X-axis. The graph shows six bars grouped in pairs: two on the left that show bars when real GDP is less than negative 1% and between negative 1% and 1%, two bars in the middle for 1% to 3% and 3% to 5% GDP growth, and two bars on the right representing 5% plus GDP growth and overall. The two bars in the middle are labeled as “the sweet spot,” with the current spread of about 250 basis points as of 30 June 2016, shown on the bar showing GDP growth of 1% to 3%. The current spread, labeled with an orange dot, is just over the mean of the range. The two bars on left are categorized as “too cold.” The bars on the right are categorized as “too hot.”

We think investors may want to consider high quality credit investments at current valuations, as they exceed yields on government bonds, which remain very low. Potential 3%‒6% returns over the next year aren’t quite the 9%‒10% for credit markets year-to-date, but mid-single-digit returns in bonds today are still attractive, especially in light of their diversification benefits in portfolios with equities. And for investors with slightly higher risk tolerances, we see the potential for 5%‒7% returns in emerging market corporate bonds.


Given the positive backdrop, how can investors choose which companies to invest in? As part of our analysis, PIMCO’s team of more than 50 credit analysts around the world, along with credit portfolio managers, focus on several key questions: What sectors are likely to see better growth trends over the next one to three years? What companies are likely to take market share in global spending? Which of these companies are likely to act in bondholders’ interest? And what companies are able to raise prices on their goods and services?

Finding trends in the industries where prices are rising can provide meaningful investment insight. Pricing power is key to a company’s financial flexibility, which is a very relevant consideration when investing across the capital structure. The dispersion in pricing-power trends creates opportunities for active management – essentially, choosing companies in sectors that are growing, raising prices and acting in bondholders’ interest, and actively avoiding other sectors.

One way of identifying and confirming pricing power is to observe recent trends in the U.S. Consumer Price Index (CPI), excluding food and energy. Trends seen here often align with those we uncover in our own sector and company analysis. Based on the CPI pricing-power trends we see today, we are favoring healthcare, building materials and companies that are benefitting from strong demand tied to U.S. housing activity.

For example, in healthcare, we are seeing investment opportunity in hospitals, select pharmaceutical companies and medical device makers. These companies can be shielded a bit from competition due to patents or operating licenses, and maintain market share in an industry that’s benefitting from demographic demand trends, among other things. It’s not much of a surprise that consumers are paying more each year for products and services in the healthcare sector; in contrast, companies in some other industries have reduced prices to sell their goods, such as new and used cars.

Figure 4 shows changes in prices from last year, affirming many trends we see, with companies successfully raising prices in the building materials and housing, or shelter-related, sectors.

Figure 4 is a horizontal bar graph showing the year-over-year changes as of June 2016 in CPI (U.S. consumer price index) components, excluding food and energy, for eight different areas. The changes, expressed as a percent, are shown on the X-axis. Medical care services, at the top of the graph, have the highest increase, about 4%. Tobacco and smoking products, and shelter, are also close to 4%. Transportation services show an increase of about 3%, while alcoholic beverages are at about 1.3%, and apparel, at about 0.4%. New vehicles show a decline of about 0.4%, and used cars and trucks a drop of about 3%.

We are finding other investment opportunities in companies tied to U.S. housing as well as non-agency mortgages. Other consumer-related sectors, such as cable, telecom and gaming should also perform well if our base case outlook for U.S. growth holds. And even though there’s been a lot of pressure on global banks this year, U.S., UK and select European bank bonds are actually very attractive.

In addition, we are seeing more opportunities in emerging markets, which are supported by technicals and signs of improving fundamentals. Countries like Brazil, Mexico and Russia look attractive at current valuations as commodity prices have stabilized and the outlook for China is one of muddle-through rather than a hard landing. In the commodity-producing sector, pipelines are attractive at current valuations, but we remain cautious on many industrial metals companies. To be sure, emerging markets have rallied this year, and the asset class can be susceptible to bouts of global risk aversion as well as idiosyncratic developments.

In sum, we continue to see numerous opportunities in credit markets, although after this year’s rally, we think it is time to be a little more selective. Spreads on U.S. corporate bonds are lower than in early 2016, but yields and potential returns still make the sector an attractive way for many investors to seek yield and income.

The Author

Mark R. Kiesel

CIO Global Credit

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All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. Diversification does not ensure against loss. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

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The Barclays Global Aggregate Index provides a broad-based measure of the global investment-grade fixed income markets. The three major components of this index are the U.S. Aggregate, the Pan-European Aggregate, and the Asian-Pacific Aggregate Indices. The index also includes Eurodollar and Euro-Yen corporate bonds, Canadian Government securities, and USD investment grade 144A securities. The Barclays Emerging Markets USD Aggregate Index tracks total returns for external-currency-denominated debt instruments of the emerging markets: Brady bonds, loans, Eurobonds, and U.S. dollar-denominated local market instruments. Countries covered are Argentina, Brazil, Bulgaria, Ecuador, Mexico, Morocco, Nigeria, Panama, Peru, the Philippines, Poland, Russia, and Venezuela. The Barclays U.S. Corporate High-Yield Index the covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. The Barclays U.S. Credit Bond Index measures the performance of investment grade corporate debt and agency bonds that are dollar denominated and have a remaining maturity of greater than one year. The index excludes Emerging Markets debt. The Barclays Intermediate U.S. Treasury Index is an unmanaged index representing public obligations of the U.S. Treasury with a remaining maturity of one year or more. It is not possible to invest directly in an unmanaged index.

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