Hello, and welcome to the Credit Edge, a weekly markets podcast. My name is James Crombie. I'm a senior editor at Bloomberg. This week, we're very pleased to welcome Kay Her, chief investment officer for US fixed income at JP Morgan Asset Management.
How are you, Kay, I'm doing great, James, thank you for having me.
Thanks so much for joining us, so we're very excited to dig into your credit market views. Also delighted to welcome back Julie Hung with Bloomberg Intelligence. Great to see you again, Julie.
Hi, I'm Julie Hung, Bloomberg Intelligence, Consumer Staples, Credit Analyst, part of Bloomberg's research department of five hundred analysts and strategists.
Just to set the scene a little bit, credit markets are rallying. Debt spreads remain very tight. That means you're not getting very much compensation for the risk of default or downgrade on corporate debt, but the mood is bullish, especially in the US. Most investors are very excited about the high yields you can get on bonds that pay very low coupons for most of the last ten years. But if rates stay where they are or as many expect fall. Fixed income investors should benefit. A FED hike
would probably cause some trouble, though. Meanwhile, issuance is ramping up. There's been a record volume of bond and loan sales as companies take advantage of the window to raise debt, front loading fundraising to avoid any potential election volatility later on this year, companies seem to have accepted that rates
aren't coming down anytime soon. Credit bulls believe that the US economy will avoid recession, earnings will stay solid, and companies are fine paying higher borrowing costs, although there's a cohort of very low quality issuers that may still blow up if rates don't fall. We talked last week about two hundred billion dollars in junk bonds that look very vulnerable at current rate levels. And there's a lot of
other stuff to worry about, commercial real estate, stress, war, geopolitics, elections. Overall, I'm sensing a bit of complacency in credit markets, given how tight spreads have become, even a bit of if you consider some of the deals that are getting done right now. But what do you think. Okay, we seem to be hearing a lot about the year of the bond a golden age for credit? What's your view?
So, James, you've said so much in your intro that I've got to unpack a few of those things. First of all, fixed income investors always have something to worry about. Remember, there's always something that can go wrong, so we're always losing sleep about things. I think you made a lot of great points about spreads yields, but I think the important thing to remember is that there's income and fixed income again, and I think people shouldn't lose sight of that.
I would submit that the era of financial repression is over. And yes, I absolutely agree that spreads compared to historical levels look tight. But there's income and fixed income, and there are attractive yields and various aspects of the investment grade markets, and I think people should focus on that instead of losing the plot on some of the macro issues like the FED for example.
Okay, you know, I definitely agree with you that fixed income investors there's always something to worry about on our side compared to you know, the equity side, which you know they seem to always be very optimistic and you know, a little more bullish than we are. What do you expect from the FED in terms of rate cuts this year.
Yeah, so, Jullie. First off, you may not know this about me, but I spent three years as a credit research channelist at JPMorgan Asset Management. Then I spent seventeen years in equities, and about five years ago I moved back to fixed income. I find that I actually prefer to worry about what can go wrong. I'm better at that thinking about what wonderful wings. Yeah, the worst case exactly. So you know, in answer to your question, our expectation is that the FED cuts probably two times this year
in the back half of the year. We've got a FED focused on the dual mandate of inflation and employment, and our view is that inflation has been coming down steadily, arguably not as quickly as the FED would have Mutt liked. There were some what we call seasonal issue use in the first quarter, but we think inflation is moderating. Some of the unemployment data has started to tick back up. Admittedly it's four percent or under four percent. Longest period.
I think it's twenty nine months the longest period sub four percent. But what we see is some underlying cracks and small businesses, and we think that high real rates are going to give the FED the opportunity to ease to ease this year.
And what do you think the risk over recession this year is and how would credit markets react to that.
Yeah, it's a good question. When we think about our base case, we think that the US economy is in a soft landing, and when we think about what the market price is in over the next three to six months, we think it's the most likely scenario remains a soft landing, and to James's point, that is essentially what's priced into
the credit markets. You do feel a certain amount of complacency when you look at spreads, and we can talk about the fundamentals in a second, seventy percent we stay in a soft landing, maybe the odds of a recession or let's call it ten percent recession, five percent of crisis, so maybe fifteen percent a scenario that could cause spreads to widen, but would actually cause rates to rally. You'd get a decline in treasury so the outlook for bonds
overall would actually probably be constructive in that. So we think about that, you add seventy percent on a soft landing, fifteen percent on either a recession or some form of a crisis. That's eighty five percent that you can collect a coupon. You know, the egg is yielding north of five percent. Now you can buy core plus strategies or even short duration type strategies with yields north of six percent, even if you get you know, you're looking at the
yield plus some total return in there. The tougher scenario for bonds would be the other side of the spectrum from recession, which would be a reacceleration in inflation and in growth, and that we think is a lower probability let's call it fifteen percent you've got. You know, if you think about that as a as a normal distribution, something like eighty five percent is a constructive environment for bonds. Fifteen percent is more problematic when you think about managing bond portfolios.
So why do you need the extra headache k of corporate debt? I mean, you're not getting your eighty five basis points over treagies. Why not just T bills and chill?
Huh? So you know, I'll confess I opened, I resurrected a Treasury direct account that I had many many years ago, and I resurrected it a couple of years ago, and I was absolutely rolling over treasury bills. The answer to your question now though, and I started last year moving those treasury bills into short duration core plus and into core plus strategies lengthening duration. And I've been doing something that I don't think a lot of people on the
bond side do, which is dollar cost averaging. I feel like in the equity markets, everyone has accepted the fact that they shouldn't try to time the market exactly, and bond markets, we see so many people looking for the exact perfect entry point. And I think what people are forgetting And you see this in the data, James. We've got six trillion dollars of cash sitting on the sidelines in money market fund So there's an awful lot of
people who are in fact t billing and chilling. And I think what they love is you sit there and you think, my goodness, this is so comfortable. I can get north of five percent yields with a duration of overnight. This is I can't lose money this way. But if you look, and you know, I think you all are familiar with doctor David Kelly. He's got this great periodical. You know, we call it the periodical elements of returns, and cash tends to underperform over longer periods of time.
I think we've got a generation of investors who've seen a one way bond bowl market with rates having gone down to almost zero percent and then a very difficult repricing two years ago, and they've got a form of you know, forgive the term, but post traumatic stress disorder, and they're afraid of both credit risk and they're afraid
of duration risk. I think we have a generation of investors who've forgotten or never knew bond math and don't fully understand that reinvestment risk is a real problem for people. So if the FED starts easing, which is our base case, later this year, then those bond yields that people those money market yields is overnight yields that people are going to get, are going to disappear. So they will have missed the opportunity to lock in longer yields.
Okay, you had talked about soft landing, and I think that's a very key term that we've kind of been hearing the second half of last year, you know, through the beginning of this year, I mean, heading into twenty twenty four. You know, as a consumer staples analyst, you know, we're always just looking at consumer behavior and what are they doing? How are they driving the economy? And there was this fear that they're just going to stop buying,
which we know, you know, consumers never stop buying. But there's always that, you know, that fear that you know, something's going to happen where unemployment is just out of this world and you know, wages are are down and it's just gonna like put the economy to a halt. But we have not seen that yet, you know, looking at the consumer and you know, we just had a you know, consumer conference a couple of weeks ago, and I do encourage our listeners to listen to the replay
because it was a very insightful consumer conference. But we're seeing, you know, two different consumers. The lower income consumers are are a little are a little more you know, hurt by what's going on. The higher income consumers are still shopping. What is your view on consumer spending behavior? Like where
do you see this going? Like, given everything's been going on in the economy, all the headlines, you know, we haven't seen rate cuts yet, Like, what is your view on consumer purchasing behavior.
I think you've articulated it very very well, July. I think the US consumer is, first of all, very resilient in terms of as long as consumers are employed, they continue they adjust their buying patterns in the face of inflation, but they tend to continue to spend it spend. So what we've seen and we can we can talk about maybe some of the trends that we've seen in the investment grade universe and some of the trends we're seeing in the assetbacks in some terms of the securitized credit market.
But as you correctly knowe Julie, the consumer represents roughly two thirds of US gross domestic product, and as a result, we focus a lot on the consumer, and we see exactly what you've noted, a bifurcation in the consumer and in the investment grade universe in particular. What you see is resilience, but bifurcation. So when you look at Walmart, Walmart's continuing to take market share from high income households, so that's income of over one hundred thousand dollars. More
than ninety percent of Americans have shopped at Walmart. With the the last twelve months, either on their online platform or in an actual store. And then if you look at their revenues, Q one revenues grew at six percent versus I think estimates were more like four point eight percent, and IBADAD grew at almost thirteen percent versus estimates that were six percent. And what was driving that was higher volumes from grocery and from general merchandise. You see similar
things in dollar stores. So if you look at a dollar Tree, for example, so an uplift in traffic coming from higher income households. So absolutely you see bifurcation, and you see some trade down. You know, you've seen continued pressure in the home improvement stores, so lows in home depot and we had been seeing some weakness and big ticket discretionary purchases, so signs that consumers are remaining very
budget conscious. But just last week Costco reported earnings which indicated some here's the term we haven't used in a while. I'll go with green shoots. So some green shoots in the consumer and starting to express some interest in buying bigger ticket items, so durables and things like that. And I think what's driving these trends are a couple of things.
Companies that are focused on the value proposition are leading and I think when you look at those Walmart's result, Walmart's had their price rollbacks were up something like forty five percent on a year over year basis. Targets had to come in and match that, cutting prices on something like fifteen hundred items in everyday categories, and that's a boon to consumers. Really lower prices. We know you we've talked about inflation, We've talked about higher prices. And what's
interesting is where this is coming from. Walmart is self funding that, So they're using price to drive traffic that's driving earnings for them. And interestingly, what you ordinarily see is the retailers pressuring the consumer staples companies to give them, you know, give them more discounting, give them things like that.
And what you're actually seeing is if you look at high qualities like Procter and Gamble, they've seen operating margin increases in the first quarter driven by pricing, volume, productivity games. And if you look at comparable companies, whether Kimberly, Clark, or Pepsi, they had all had similar similar results. So I think there have been some benefits of tapering inflation. What you've seen of the companies that are leading on price and rolling back prices or driving traffic, and that's
a further boon to consumer. So if they stay employed, you've got this moderation in inflation. It's very constructive. I think some of the warning signs and maybe this is a segue to talk about it is on the Target management call after Force first quarter earnings, they noted that one in three Americans have maxed out or nearing credit
limits on at least one credit card. So those are some of the warning signs that we're looking at, and I'm happy to dive into that, or you can tell me where you'd like to take this, Julia James.
Yeah, that's that's actually my next question about auto loans and credit card loans and deficiencies. Again, like you know, we're seeing a lot of differing views on that.
Some people are seeing.
You know, when you're looking at default rates on these auto loans or credit card loans, they're higher than it was last year, but then they're pretty flat to pre pandemic. What have you been seeing in terms of like the underlying performance of these loans.
Let's dig into this because I think it's actually really really interesting. So, first off, low income low FICO consumers continue to struggle. We've seen some stabilization in their level of stress, but that's actually at lower levels than we saw pre COVID, So some slowing wage growth, some slowing wage growth, some pockets of sticky inflation. What we've seen is excess savings have been depleted. On the other hand, and this really goes back to your original question, Julie,
on the bifurcation of consumers. The other hand, middle income, upper income higher fight go score consumer performance that has been stronger. Interestingly right now, that's deteriorating at a faster rate, but from very historically low levels. So if you think about that, the upper end consumers, those tend to be homeowners who are benefiting from the lock in effect of low mortgage rates. They tend to be asset owners, so they own real estate, they own stocks, and that's actually
performed very well. And higher income consumers also still have access to excess savings from pre COVID levels. Lower end consumers, back to that bifurcation concept, they're not benefiting from this. They're struggling with a higher debt burden. They're struggling with reduced excess savings and other headwinds. Think about the fact that it looks like student loan repayments are going to come back, and I think it's important to actually take a couple of step backs and think about why we
are where we are. And one of the things that we started talking about, gosh, I think it was in twenty nineteen, twenty twenty, or actually I guess it was two thousand and twenty twenty one we started talking about is what I call fycoscore inflation. This is everybody's talking about consumer price inflation, but fycoscore inflation is a really
interesting driver in the dynamic on the consumer side. So if you go back and remember what happened in COVID, you had stimulus payments, transfer payments from the government, you had debt payment moratoriums, and different policies that actually created what we viewed at the time and continue to see as unsustainable positive credit performance, and that translated into pretty significant fycoscore inflation to the tune of like fifty points. So let's use some examples on this. Roughly half of
Americans have a FCO score. Who have fycoscores have a fycoscore over seven hundred, and you know there's some fycoscore inflation there, but median's roughly neutral. But when you're looking at subprime borrowers, so four hundred to five hundred or five hundred to six hundred, they were seeing scores go up by fifty eighty one points, and that translated into credit creation. So your five hundred borrower becomes a five point fifty borrower, and then bank's credit card companies are
are much more willing to lend to them. So we saw credit availability spike in twenty twenty one twenty two, and credit card lenders in particular were increasing credit limits very rapidly, so that drove down credit card utilization, which we've now seen normalize over the six months. But if you think about that, that at the time was a
very virtuous cycle. You stop making payments, you stop spending on things because of the moratoriums, You get a transfer payment, you look like a better consumer, Your bank gives you, your credit card companies give you access to more credit. That makes you look even better. But unfortunately there's a reckoning on that, and we've started to see that reckoning.
And as I said, the subprime consumers were the ones who saw the biggest benefit and credit scores, and that's now where we've seen the most acute stress in consumer performance data, and it's it's not surprising. I think it's also important to remember that when you're looking at the consumer and you're looking at the asset back market, the
probability of default is not linear. So a true five hundred borrower, a true FYCO score borrower at five hundred, has a fifty percent higher probability of default than a true five point fifty borrower. So that inflation that I talked about in FCO scores of you know, five hundred borrowers going up in the eightieth percentile, up ninety three points on a FICO score, that had a pretty material effect.
So I think it's important to understand some of the backdrop and that's what's driving a lot of the trends that we've seen. Let me pause there if you want to jump in.
I wanted to ask, okay about the trade here, what's the what are you positioning around it? I mean, you talk about abs. We've seen huge issuance this year. It could be a record year, even if things slow down around the election. Is it offering better value than investment grade debt right now corporate debt.
So the short answer to your question is we see value in both, but we see a lot of value in securitize credit and maybe so yes is the answer to your question. You referenced yields in investment grade in the low fives, and we talked about some of the consumer and retail sectors. Their particular narrow Those sectors are trading inside of the investment grade universe, so that's not necessarily where we see the most opportunities. Some other sectors
have wider. When you look at asset BAC securities, you can get high quality investment grade asset back yields north of six percent, north of seven percent, depending on some of the things that you're looking at. Do you think about the trends that I just talked about. I think we were relatively early before some of the issues and
sponsors understood this dynamic. We had calculated this credit score inflation, and we started demanding either better pricing, better yields for some of these things that we thought were more at risk, or better credit enhancements. And what we've seen, though, is this trend which we were I think thankfully early to catch on to is now better understood in the market. So what you've seen is the tightening of the credit boxes. So essentially credit companies are giving consumers less rope so
they can do that. The damage has been done. A lot of the damage has been done, and so you saw weakness in some of the vintages of twenty one twenty two, which we've talked about. Now you see kind of twenty three twenty four with the tightening in the underwriting. We've actually seen much higher performance in terms of credit.
In twenty twenty two, subprime defaults were kind of twenty to thirty percent higher than what we would have expected in a typical cycle, and that really is due to the factors that we talked about, sort of too much credit given to subprime borrowers in this FIICO credit score. So we see attractive opportunities and asset backed securities we see, you know, when you look it's an interesting topic to go down this rabbit hole. When you look at the ag you know it's it's I'm not a big fan
of passive. You can argue I'm talking my own book, but we see active ETFs, mutual funds, et cetera. There's tremendous flows going into passive ETF that go into the AG and that doesn't actually offer the opportunity to invest in sectors like asset backed securities. So there's a lot of fixed income which provides yields that are beyond the traditional AG type things that people are looking at. I would say there's absolutely an element of caveat MTUR in terms of uh looking at you need to do the
underlying credit work, you need to understand the dynamics. But we've just talked about, but we absolutely see opportunities for yield pick up there.
And going back to your comment about you know these like they're they're giving them less rope to borrowers overall, I realized that.
Was probably a horrible analogy, and I stopped where I was going there.
Do you think that overall that that's a good thing though, because you're absolutely kind of yeah, you know, avoiding the financial crisis from back years ago. And do you think that this will keep the ABS market attractive because your underlying loans are a little I guess I quote unquote better quality.
Safer exactly, Julie. The damage that's been done was really done in the twenty twenty one twenty twenty two vintages when this wasn't fully understood. I mean, if you if you look at it in a in a in a single case, that makes sense. Look, this borrower is presuming that is performing better than we would have expected. Her balance sheet has improved, she's got excess savings, her credit utilization is lower. Let's increase her fight go score. That's logical.
But when you do that over a whole pool, and so much of it was driven by pandemic type behaviors, the transfer payments, the moratoriums on student loans, et cetera, it becomes problematic. And that's what's driven the type of delinquencies that we've seen, and I think that scared people out of the asset back market, and I don't think
that's necessarily the case. I think going forward, as I said that, there's been tightening of underwriting standards and I think the outlook is better, but you still have to do your work. In this sector. It's not as it's not as transparent as investment grade corporates. When companies are making regular quarterly announcements and there's a lot of transparency and visibility on what's going on underneath, I think is an important understanding what.
Some actual sections are were talking about here, Ka. We've seen some big whole business securitizations where a company pledges most of its assets as collateral, including franchise piece. For example, Subway, the restaurant chain recently sold three point three five billion of asset back bonds to help fund it's by that's the biggest I think we've ever seen of it's kind, and it may come back. But do you do you are you talking about that kind of thing or is
it sub prime auta or data centers? A movie that there are so many different things included in in abs, So what are you thinking of when you think about Juncy.
It's an excellent question, James, and I must confess I was a little surprised by the security. So you make a great point, a great question. It feels like increasingly anything can be securitized. And you're referring to a deal that came last week that was hotly over subscribed. I think there was substantial tightening the Subway deal, and it's, as I understand it, the securitization of future franchisey payment
to Subway. I was actually talking to my counterpart our colleagues in equities this morning to ask if they expected that to be a source of financing for additional restaurant companies. I think in the five year that came at one thirty eight. So when you're looking at retailers probably inside of eighty basis points over treasuries, it seems unlikely that that's going to be a source of funding for investment
grade s and P five hundred type restaurant companies. But I think this trend of increasing focus on securitization is one we're going to see. The answer to your question is we'll look at all of it. I think I wouldn't categorically rule out any of those sectors. But you're right, securitizations can be everything from business jets to revenue franchises to old fashioned auto loans, consumer loans, credit card loans.
We've got a strong research team and we're digging in the weeds on all of those things, and it really comes to where we see relative value and where we see where we see opportunities. But it's to your point, much more it's a much more diverse market than looking at retail investment grade issue or A or a consumer products company or something like that.
But other sector is right now that you really like?
We're we see opportunities across the board. I think it's less about a particular sector, I would say, and more about individual credits.
And is there anywhere that you're particularly concerned maybe subprime auto or I mean, we're not getting back to the Bowie bonds of the you know, fifteen years ago, but are we getting to As you said, anything could be securitized and we've seen some art deals and that's the thing. Is it getting very fruthy?
Now?
Are you starting to worry?
As I said at the outset, James, I always worry. I'm actually paid to worry. But yes, when I see securitization of franchisee payments on restaurants, that that feels later cycle to me. When I think about where we are in the economics cycle, that feels more challenged to me. But I would I would counter that and bring you back to the investment grade universe that we were talking about.
And when you look at corporates, while we've seen a deceleration in revenue growth, you've seen actually from our bottom up perspective, our investment grade analysts are expecting estimates over the next four quarters for revenues to grow three to four percent. You've actually seen some acceleration in EBITDAG growth. So we saw Q one EBITDA and this is quoting statistics on the US investment grade industrial companies for median performance.
You saw cash flow or EBITDAHN in the first quarter trailing twelve twelve trailing twelve month basis up three point nine percent. That's an acceleration from last quarter. You see you know, you ask me about particular sectors. You see strong cash flow momentum growth in tech, in healthcare, and energy. And then I think kind of the third aspect of that, what do we see happening in leverage in the investment grade market. See, leverage is actually flat, so you see
improving cash flow, stable leverage. And if you look at upgrade down grade ratios in the investment grade universe and you look at the first quarter data, those have been really strong. So something like two hundred billion dollars worth of investment grade credits upgraded in the first quarter. It's
almost three percent of the index, which is meaningful. And you've seen strong upgrades of exceeded downgrades every quarter for the last two years, and I think a lot of those upgrades really interestingly, James, are happening in the triple B rated bucket. You've seen a decline in the share of triple B minus debt and the index falling to the lowest level since twenty eleven. You know, and triple B rated buckets now almost half the IG It's about forty six percent of the IG index. It's down more
than five percent from the peak. So I know you've talked about at the outset, and I agreed with your point that spreads are tight, but triple B is the lowest percentage of the IG market. Single A is the highest percentage of the IG market in more than a decade. So there's some some real strength in in in the fundamentals that we see, and I think some of that actually does justify some tighter spreads.
But the one thing I do look at, and I'm a real credit geek, I have to admit, okay, but the spreads between spreads are just getting crushed. Everything's just converging. So you're telling me that a triple B rated bond is similar risks for single A across the board. It's just, you know, I mean, that doesn't make sense to me.
So I think a couple of points. I respect your point, James, and I can relate to your credit geekiness. I consider myself one as well. But let's go back to a couple of things. There are a lot of people yourself included, it sounds like, who are focused on the tightness of
the IG market. Absolutely, you're right the old heuristic. And I celebrated my twenty fifth anniversary at JP Morgan Asset Management last week, so you can't see me on a podcast, but I got plenty of gray hair that I've earned in the fixed income markets, But the old heuristic was you would want to buy investment grade credit at spreads of you know, one hundred and seventy hundred and eighty over to compensate for a risk of recession. And we
are or soft landing, but arguably late cycle. And when you see spreads inside of one hundred basis points, it absolutely causes pause to people. The two things that I would remind people of are number one, we're in a soft landing. In a soft landing, well, the first point would be the fundamentals that I just just articulated. You've got an investment grade universe. That is higher credit quality
than we've seen in about a decade. The same is actually true in the high yield index, but it sounds like you talked about that last week, so we won't go down that tangent right now. But you've got higher quality fundamentals. The other thing is you've got a soft landing. In prior soft landings, you've actually seen so a couple
of things. Number one, IG spreads actually trade inside of one hundred basis points something like a third of the time, So this is not a completely frothy, never exists type environment. This is roughly a third of the time. I think what's unusual is it's highly unusual for the FED to be able to achieve a soft landing. It's having pilot'slicense.
A nice soft landing is difficult to accomplish. You've got all these tailwinds, all these turbulence, and all these different things going on, and the FED, it appears for now, has absolutely stuck a soft landing, which is terrific. And that's an environment where high quality yield performs exceptionally well. So the tights on investment grade that's a universe. So let's call them now let's say eighty five basis points eighty basis points. The tight on that all time is
sixty two basis points. I'm not necessarily saying that that's where we're going. But if the FED does in fact pull off the soft landing and we get a gentle decline in UH and employment, gentle rise and unemployment, continued moderation and inflation, you get the FED easing, You get
a distanversion of the yield curve. We are going to have an avalanche of money into fixed income, and that avalanche is going to flow into high quality UH fixed income at attractive yields that people aren't going to see again for a period of time. And I think that could well propel and investment grades spreads tighter. Yeah, you know that would be the book case. Not necessarily something I make a lot. As I said, I'm more likely to be worrying, but you know, I.
Agree with you that, you know, the credit fundamentals have been better. And I think a lot of these companies when you're looking at corporates, and you know, specifically like for me, like Consumer Staples, they they got they got scared after the pandemic. And you know, I'm going to go back to you know, there's a big consumer conference
every year that they have. February twenty twenty, I attended the last it's called Cagney, the Cagney Conference, and what the CEOs and CFOs were saying at these conferences were Okay, you know, everyone's asking them like, what's going on with China, And all they could say is, well, we're watching it. We're watching it. Then it's got to be less than a month later, you know, we're in full pandemic mode.
Everything got shut down. Nobody expected it, and I think there there was this push recently, like the past couple of years, into let's focus on our balance sheet. Let's make sure we have cash on hand, let's make sure we're not overlevered, and you know, let's work towards our net leverage ratios to keep you know, good credit ratings
in case we need to tap the bond markets. Because they didn't expect the speed of the pandemic, they didn't expect what was going to happen, and I think that in a way it was a good thing because it propelled them to focus a lot on the balance sheet and to focus on you know, very good credit quality. Just so they could avoid another situation. And like if ebadized down they have a lot of debt that they
could avoid being downgraded. So I agree with you that you know, we're seeing a lot of corporates just you know, overall credit quality is just so much better than it was a few years ago.
So Julie, I agree with everything you said, and I would add a couple points if I may, If we were to rewind the clock, and if you all had had me on here in the fourth quarter of twenty nineteen, or actually in January, so sort of late twenty nineteen or early twenty twenty, I would have cited credit statistics to you that were actually Alarming's too strong of a word, but concerning what we had seen was a material deterioration in credit metrics, whether you're looking at the IG universe
or the high yield universe. So you saw both gross and net leverage had been achieved reached in twenty nineteen early twenty twenty, pre pandemic. I'm talking about December January. They reached levels that we hadn't seen really in a psych So it struck us from a credit perspective, and we agreed. I worry about things that I don't need to worry about, but it struck us as we're late cycle in an economy and companies have too much leverage.
So we had been taking risk out of portfolios at that time, and I did not predict a pandemic that was not on my radar. Same thing that you said about what was going on at Cagney. But companies were horribly positioned for the pandemic. They had too high leverage. And then what you saw if we switched gears to the high yield market, you saw a six percent default rate in high yield in twenty twenty, which really demonstrates how poorly positioned companies were for any type of slow down.
And I think what I would say is the entire corporate universe found religion and if you look at the data, extraordinary discipline. So what did you see? Dividends cut or curtailed, share buyback programs cut, and you saw a renewed focus on balance sheets. And what's really interesting to me given my background in that time period is you see an alignment of bondholders and equity holders of both looking for you know, companies rewarded in the equity market for focusing
on their balance sheets. I mean that was the dawn of for the first time in history, the energy companies, exploration and production companies finally actually focusing on free cash flow, not just growth for the sake of growth, and equity markets doing that. So and you look at the underlying dynamics. The high yield market had way too much concentration in the energy market, so you have now a more diversified corporate bond market, a management team, a team of CFOs
and CEOs who've been through a crisis. They all planned and I did too. We had an expectation that the recovery post COVID in terms of cash flow would have been much slower and much longer, and companies have benefited from that. But instead of immediately going wild with share buybacks and massive dividend increases, they've actually been quite measured. So,
as we noted before, leverage remains remains flat. You know, whether on a net leverage basis in the IG universe it's something like one point nine times, So you know, we've seen a little bit of re leveraging in the single A space for some of the acquisitions like Conico acquiring Marathon, but we think those companies are going to continue to maintain single A and there remains a focus
on balance sheets, so that will fade. You know, everything goes in cycles and people will get over the pandemic and they will tell themselves that was a one off, and we'll get excesses back into it. But we're we're not seeing that type of behavior in the corporate market.
Yeah, yeah, I mean I definitely agree with that. You know, we are seeing a little more comfort in taking on more debt, but there is there also is this Okay, if we lever up to do it acquisition, we're going to pay that debt down as soon as possible. And again that goes back to the whole like, let's focus on credit quid.
Yeah, I agree with that.
It's okay when you look around at everything, you get to see and I know it's very case by case for you, but if you had to pick one thing for the next let's say twelve months, where's the best relative value for you? In credit?
Oh, I would put money in securitize credit.
And it's mostly around the consumer.
Yeah, asset back consumer. Yep, that's what I would do.
Okay.
I think with good research discipline, I think you get very strong yield, strong carry, and I think the consumer is going to be okay, especially if you've got good, good credit research behind that.
And in terms of the problem areas that downgrade the defaults, what are you most afraid of right now?
You know the general rule and having done this for the last twenty five years is, and you touched on it earlier in this podcast, James, is when there are excesses, when too much money goes into a particular market, that tends to weaken discipline and investment. So if you look at the leverage load market, the high yield market, and the private credit market, those are all roughly the same size. So there's something like one point six trillion dollars that's
flowed into the private credit market. And I think some of that will do just fine. I think there's been so much money that's flowed into that market, I have concerns about the credit quality in that and how that will all turn out.
Is that particularly risky area right now? Private credit? I mean a lot of people have flagged it. Even Jamie Diamond has talked about it. But is it a big concern of yours? Private credit specifically?
So fortunately for me, so two things. Yes, I agree with Jamie, and secondly, fortunately for me, I focus on the public market, so it's not something that I am worried about in terms of investing on a daily basis in our portfolios. But I worry about what delinquencies, what amend and extend will look like that market, and whether there will be consequences that will ripple through into the high yield and the lever blone market. Those are where where my concerns lie on that.
And given what we've discussed over the last forty minutes or so, you don't seem that concerned about a serious, sort of big risk off move that could cause some big volatility a bit if there was. I mean, is there any way to hedge that in credit right now?
That's a great question. You know traditional bond portfolio management. Is you hedge risk off with duration in portfolios? We've had what I would call wrong way correlation for a period of time, I think, and as you've noted, volatility has been pretty high in the broader bond markets. I think that's a function of uncertainty about the FED. So I think two things. Number one, when people gain confidence that the FED in fact will ease that they absolutely
will not hike. They may stay on hold for longer than people had originally expected, but I think that will bring down volatility, and once the FED starts to ease, I think that helps. That helps with concerns around that. I think the other really interesting thing, and I hate to say this because it promotes poor behavior, is you know, you get some terrible risk off move some crisis. Look
at Silicon Valley Bank last year. I think everyone knew there were some excesses and a lack of duration management and on the part of some of the banks, But the FED came in and essentially bailed them out. So is there still a FED put? Probably so, But I wouldn't say it's not fair to say that. I don't worry about a risk off environment. I think we have a particularly fraught geopolitical environment. We've got elections over the weekend and three different emerging markets. We've got US elections
coming up. There's a fair amount of geopolitical conflict in the world. I don't think it's I don't think it's I wouldn't say there's zero percent chance of probability. I think I said at the outset, you could easily five percent chance of some sort of crisis that should be a good environment for duration for treasuries. In that environment, agency mortgages without perform as well.
Great stuff. Okay, her chief investment officer for US fixed income at JP Morgan Asset Management. It's been a pleasure having you on the Credit Edge Money.
Thanks, Thanks James, Thanks Julie, Thanks Gabe, and of.
Course Julie hung with Bloomberg Intelligence, thank you very much for being on the show.
Thank you for having me back.
Bloomberg Intelligence is part of Bloomberg's research department, with five hundred analysts and strategists working across all major markets. Coverage includes more than two thousand equities and credits, and also includes outlooks on more than ninety industries and one hundred market industries, currencies, and commodities. Check it all out on the Bloomberg terminal, and please do subscribe wherever you get your podcasts. We're on Apples, Spotify, and all other good providers,
including the Bloomberg Terminal. Give us a review, tell your friends, or email me directly at Jcromby eight at Bloomberg dot net. I'm James Cromby. It's been a pleasure having you join US again next week on the credit edge.