2022 was a year that many will want to forget. Punishing inflation combined with an aggressive Fed hiking cycle wreaked havoc on traditional markets. There were few places to hide as stocks and core fixed income both ended with double-digit declines for the first time in 150 years. Corporate credit markets were not spared either; an initial sell-off in duration-sensitive, higher quality credits eventually gave way to recession concerns and underperformance by lower-quality and lower-rated assets.
As we enter 2023, credit markets are faced with crosscurrents. Despite sharp index level declines last year, corporate fundamentals continued to improve and defaults remained benign. The economy, however, is likely to slow and the odds of a recession have risen. But what 2023 has that 2022 didn’t, is a starting point of much higher yields, which could serve as a cushion should spreads widen this year. Markets may remain volatile, especially if a looming recession materializes, but credit markets are, in our view, well-positioned to navigate another uncertain environment in 2023.
Key takeaways
- 2022 was a challenging year for markets, as inflation, rising interest rates, a hawkish Fed, geopolitical tensions and recession fears weighed on many traditional asset classes. High yield (HY) bonds ended the year down -11.22% while loans, which were buoyed by their floating rate coupons, lost -0.60%.
- Despite these headline declines, a benign default environment and strong corporate fundamentals kept spreads relatively maintained. Yields in each market have, however, risen substantially, with HY bonds and loans each offering loans in excess of 9%. Historically, forward returns from similar starting yield levels have been attractive.
- Many of last year’s uncertainties remain, which we believe may continue to stoke volatility. Plus, the probability of a recession at some point in 2023 has risen substantially. Still, we believe the strong fundamentals that currently support credit markets make them relatively well-positioned to navigate this environment. We stress a need to remain active and prefer an up-in-quality approach to credit, which includes a preference for bonds over loans and higher-rated assets within each market.
