Global corporate credit 2022 outlook

With contributions from: David Todd, Head of Global Corporate Credit Research; Paul English, Head of US Investment Grade Research; Andy Geryol, Head of Global High Yield Research; Sam Morton, Head of European Investment Grade Research; and Yi Hu, Head of Asia Credit Research.
Overview
When we formulated our 2021 credit views a year ago, we hoped the path to critical mass vaccination was relatively clear, although we were conscious of the variant threat. Of course, the global Omicron wave has thrown the pandemic recovery off track, but all indications are that symptoms are more manageable and, we hope we have passed the peak in global disruption. Supply chain concerns are still front of mind, but the expectation of growth from here is stronger. Exactly how we get there is still dependent on policies set by governments and regional and cultural perspectives, the underlying trend being a move away from zero-tolerance along the spectrum of approaches. Against that backdrop, we share our credit team’s expectations for 2022 and perspectives on key credit asset classes.
US investment grade
The US investment grade credit market enters 2022 on solid fundamental footing, despite notable uncertainties related to the global pandemic and transitioning monetary policy. Leverage trends among industrial issuers have shown improvement from pandemic-related peak borrowing, as issuers have generated sufficient profitability to reduce and refinance debt. Financial issuers have begun to relax excess capital positions, while retaining strong balance sheets and profitability, as credit costs remain low and net interest margins begin to increase. While volatility in quarterly earnings is expected in the first half of the year, as issuers deal with rising input costs and supply chain disruptions, most companies are experiencing pricing power that is expected to maintain sufficient margins. Consumer confidence will likely be a focus in the coming year as fiscal stimulus is removed.
Valuations begin the year well off the tights, but in a range that remains less attractive, in our view, than historical averages. The US investment grade market continues to be supported by foreign flows searching for high quality, positive yield. Going forward, the pace of removal of policy accommodation by the Fed could negatively influence the marginal demand for US investment grade credit. Supply remains robust to begin the year as issuers race to issue ahead of potentially higher funding costs.
European investment grade
Our 2021 forecast for European investment grade credit spreads turned out to be close to realized levels, though some late-year volatility brought valuations back from a bull case outcome. Top-down thoughts for 2022 are driven by the continuation of ECB bond buying programs and the idea that excess returns will likely be driven by carry and the ability to generate alpha from specific investment themes and careful security selection. Currently, we see good opportunities in the energy and real estate (logistics) sectors, subordinated bonds of financials and companies with favorable fundamentals that offer spread pickup.
With valuations at the tighter end of the historical range, we expect potential outperformance in the “crossover space”. BB rated bonds that don’t benefit from ECB bond purchase eligibility and/or are rising star candidates that are already relatively rich for core high yield funds may offer attractive opportunities. We forecast net new issue supply of European investment grade to total around EUR100 billion in 2022, which, at just under 4% of the Bloomberg Barclays Euro-Aggregate Corporate Bond Index, does not represent a significant headwind, in our view.1
Finally, the green bond market has been bolstered by a surprising growth in sustainability-linked bonds, which focus on “key performance indicators” rather than the use of proceeds and are, therefore, more flexible from an issuer perspective. We use an assessment framework to evaluate the criteria of all ESG-labelled bonds and expect this type of investment opportunity to gain further market share, while noting that a relative scarcity of bonds has led them to trade rich to non-labelled equivalents.
US high yield
We are beginning 2022 similarly to 2021, but with greater conviction around good-to-improving fundamentals, and spreads are even tighter. Typically, good economic times warrant an overweight to lower quality credit. But we remain wary of valuations, especially among CCC rated issuers. We are still favorable toward the energy sector and believe it provides compensation for risk in several areas. It is also an industry that benefits from the inflationary pressures we are currently experiencing. Interest rate pressure, driven by concerns about upcoming Fed actions, will likely be a headwind for higher quality credit, at least early in the year. Rising star candidates are a potential exception where bonds remain wide of investment grade comparables. Overall, we anticipate a year of sub-coupon returns in US high yield. Given that we are beginning the year at spreads just below 300 basis points, we believe there is limited room for spread tightening from here.2
Corporate fundamentals are in very good shape, with many industries fully recovering to pre-pandemic levels in 2021. The high yield market’s overall leverage statistics have dramatically improved as a result, and appear headed toward decade lows. The anticipated healing in COVID-exposed sectors - especially travel, leisure and entertainment - should help. Default rates are low by historical standards and should remain low this year. Even in our bear case return forecast, we believe it would take time for bear case conditions to cause a rise in defaults and they would not likely impact this year’s default rate. Unfortunately, the fundamental improvement and low default environment is already largely reflected in spreads. The recent rise in interest rates has helped increase yield levels, providing a perception of value in certain areas. Still, when spreads are compared to 10-year averages, many sectors still screen very rich, in our opinion.
Last year, the US high yield market saw a record level of new issuance. The use of proceeds remained quite conservative, however, with a high percentage of deals dedicated to refinancing. Riskier transactions became more prevalent during the second half of the year. We expect new issue volume to be lower in 2022, down by 10% to 15%, but it should rank among the highest levels of annual issuance historically in the US high yield market. The use of proceeds is likely to be more aggressive, with mergers and acquisition and leveraged buyout activity leading the way, and shareholder-friendly (dividends/buybacks) deals on the rise. While default rates should be at, or near, record low levels in 2022, this new crop of deals will be important to watch for its impact on the future default cycle.
Asian credit
We are increasingly optimistic about China’s economy and the overall Asian credit market in 2022. This contrasts with early 2021, when we were concerned about China’s tightening policy measures. Chinese regulatory pressure on key sectors, such as the property sector, has reached a peak and credit growth is expected to pick up, though we do not expect a sharp rebound. Although heavy maturities are coming due for onshore and offshore property issuers in the first few months of this year, and there may be further defaults by weaker issuers, there are signs the government is seeking to relax some measures imposed on the property sector, such as the possible easing of rules surrounding developers’ escrow accounts to help ease cash flow concerns. In this environment, we favor low beta, high quality names since individual company credit fundamentals are likely to diverge.
Among state-owned entities, we see a relative value opportunity in BBB versus A credits and favor certain step-up perpetual bonds, due to their limited supply and potential spread pick-up. Local Government Financing Vehicles (LGFVs) outperformed in 2021 but we currently see spread levels on the tight side. Fundamentals are diverging, which should present potentially good opportunities for investment differentiation this year.
Tech company spreads have stabilized after China’s regulatory clampdown in 2021 and third quarter results showed double digit revenue growth. In the financials space, we see little relative value in the core areas, but the tier-two subordinated space offers value, in our view. With strong government support, we believe the Chinese asset management companies are also interesting at wider spread levels. Given opportunities presented by the property sector, we see room for the outperformance of selected higher-quality property developers.
Footnotes
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1
Source: Invesco estimate, Bloomberg L.P. Data as of January 20, 2022.
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2
Source: Bloomberg L.P. Data as of January 20, 2022.