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2021 credit market outlook

Yahoo Finance’s Julie Hyman, Brian Sozzi, and Myles Udland discuss the credit market with Matt Brill, Invesco Head of U.S. Investment Grade and Senior Portfolio Manager.

Video Transcript

JULIE HYMAN: First, though, let us talk about the credit markets. We've been talking about that stimulus bill being signed today by the president. To talk about that and much more in terms of what's going on with credit, I want to bring in Matt Brill. He is Invesco senior portfolio manager and head of US Investment Grade.

Matt, thank you for being here. So before we get into the bigger picture for Investment Grade Credit, I do want to ask about the stimulus effect on the credit markets, if any, or if you can extrapolate through what this is going to mean for rates, and therefore the ripple effect to credit here. What are you watching?

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MATT BRILL: Yeah, good morning. And we're seeing a little bit of an uptick in rates on the day, on thought that this is a little bit more deficit spending. It's also good for the economy, though, so you're going to see GDP potentially accelerate in the first quarter because of this. So that's going to cause rates to go up a little bit over the near term.

And other things that are going around with the stimulus is it's good for the retail sector. So we're seeing credit spreads within the retail names are rallying on the day, the thought that consumers will have more money to spend going into early next year.

MYLES UDLAND: Matt, here on the show, we usually talk about the equity markets and what's happening there. I'm wondering if maybe we could take a step back and talk about what's happened in credit this year, how quickly the market came back, the state of credit markets right now. Because I think-- again, you see what happens in equity prices, but a lot of that is backed up or underscored, whatever word you want to use, by how easy it is for companies to really clean up their capital structure basically for free, I guess, compared to how you learned it in the textbook.

MATT BRILL: Yeah, we don't think it's for free. It's definitely low, though. It's definitely low versus where it historically has been. But your point is exactly right. When the credit markets were fixed back on March 23 when the Federal Reserve stepped in and said they were going to start buying corporate credit, it's no coincidence that the equity market started to do well after that. So lower rates of access to capital is all very good for the equity market. Our views going forward is that companies have borrowed a lot of debt, and that was what they needed to do to survive.

So you mentioned consumers putting a lot of cash on their balance sheets, and we think that might happen with the stimulus. But companies have borrowed a lot of money just to have it sit in cash. They wanted to make sure they got through 2020. Now that they're at the end of 2020, obviously we're not out of this thing yet. But we're a lot closer to what the life is going to be when it becomes normal again. So once we get towards normal, these companies don't need this much cash anymore. And so we think they're actually going to start paying down debt, and in that regard, that's really setting up for a nice 2021.

BRIAN SOZZI: That's right, Matt. We're far from out of this, from an economic standpoint. And to that end, what's your outlook for default-- corporate defaults next year?

MATT BRILL: Yeah, so this year was a tough year. So even though corporations were able to kick the can down the road, as we like to say, by borrowing some debt, there were still a number of companies that just couldn't make it. Most of them were in the energy space. You saw some in travel and leisure as well. So we're going to come in around 6 and 1/2% defaults for the high yield market in 2020.

But going into 2021, we've really reset the deck, if you will. So we've really washed everything out. There's still some that are hanging on, but the number of zombies aren't really there. I think we're in the past. So the expectations for 2021 are more around 2% to 3%. So you're going to 6 and 1/2% down to 2% to 3%, it's going to feel like a much better credit environment.

The other thing I'd point out is in the CCC space, there's a lot more cyclicals than there historically has been. So in the past, you had mainly energy names. Now it's mainly cyclical names, and if you get a recovery in the market, or the recovery of the economy, then these cyclicals should do well, and they should hang on and not fall.

JULIE HYMAN: At the same time, what are you expecting in terms of rates? Because if we do see rates start to tick up more meaningfully, even if there aren't necessarily as high a number of so-called vulnerable companies-- companies vulnerable to default-- do you still have some risk there, as we see rates tick up, and the enormous amount of debt that many companies have taken on that you could see defaults, maybe not in 2021, maybe going into 2022, another wave?

MATT BRILL: Yeah, that's certainly a risk on the horizon. I think companies have expressed the ability, or the willingness to pay down debt. Now whether or not they actually do it is another thing. Companies took on a lot of debt, and they need to pay it back. So we need to actually see them pay this down, or else credit spreads will go wider in 2021. If they're not ahead of the curve, then they're going to have to pay for it in 2022 or beyond.

But we do believe that the equity market is in favor of companies paying down debt. They saw what happened in early 2020 when you had companies that were potentially over levered. All of a sudden, the market froze up and they didn't have access to capital. So they were concerned at that time that they were going to default. They don't want to go through that again. So it's kind of-- they saw the worst that could happen, let's go ahead and pay down debt. Yeah, sure, we can buy back some stock, use some for Capex.

But really, we just want to get our balance sheet in order. And if our balance sheet is in order, then we think that when the market recovers-- the economy recovers in 2021, that they'll be in good shape, and if the economy doesn't recover, then they'll survive. And that's the thing, is we're still not out of this, as you just pointed out. We need to make sure that we're 100% certain we are before you really start to be pressured in terms of putting money back into stock buybacks.

JULIE HYMAN: And Matt, just quickly, we're not going to have as much issuance in 2021 as we did in 2020. It would be hard to see that, right? You say companies are going to be paying down debt. Does that make your job harder, in terms of finding opportunities because there's not going to be as much supply out there?

MATT BRILL: It does. Every year, it feels difficult. Right? It felt difficult back in March, but it's going to feel difficult in January to find new opportunities as well. So as companies issue $1.8 trillion in 2020, they're only going to issue probably about $1.1 trillion in 2021.

So we're all going to feel like we're starving to find paper, and so if the inflows keep coming, and it's going to be more and more difficult to put that money to work. What that does mean, though, is the market will be supported, and it generally means that credit spreads will go tighter. Our call is for credit spreads to go to their all time tights in early 2021 because there's not as much supply, and because there's still a lot of demand with roughly $17 trillion of negatively yielding debt around the globe.

JULIE HYMAN: All right, Matt. Thank you so much. Appreciate your time today. Matt Brill is senior portfolio manager and head of US Investment Grade at Invesco. Appreciate it.