On the lookout for entry points

Economy We expect the U.S. economy to weaken in 2024, though the Federal Reserve’s recent dovish pivot has changed the calculus a bit. The probability of rate cuts in the back half of 2024 has risen substantially, but the Fed refuses to declare victory on inflation. While our forecasts lean toward a modest recession, a deeper downturn cannot be ruled out. That represents the biggest risk to the high-yield market, as it likely would lead to considerably higher spreads and default rates.  

Valuations Spreads ended November very tight versus historical levels. The spread to Treasuries (as measured by the Credit Suisse High Yield II benchmark) was 397 basis points at month-end versus a long-term median of 494. This development is driving most decision-making today. Investors seem to be pricing in a Goldilocks soft-landing scenario that is far from certain. When spreads are this tight, issuer fundamentals and free cash flow become paramount. You don’t want to own the underperformers when the tide turns and spreads widen. Markets can move quickly, so we are focusing on being nimble and ready to act when an attractive entry point emerges.

Green shoots Successful managers in 2024 will be able to capitalize quickly on the first signs of an economic sea change. We think that a slowdown or recession would be a sign to add or increase high-yield exposure as spreads likely will widen and relative valuations improve. Also, duration in this market is relatively short. Over the last decade, aggressive deals have been financed in the leveraged loan and private credit markets, boosting the credit quality of high-yield bonds. Be ready to deploy capital to high yield when broad valuations improve.