• All three traffic lights monitored by Janus Henderson Investors’ credit team continued to flash
red in Q1 2023 with a deterioration in access to capital following the banking crisis and cashflow
and earnings facing further threat from recession.
• The credit cycle has moved lower and will continue to do so over the coming months.
Tighter credit conditions could depress US GDP by 0.3% to 0.4%, while rate sensitive parts of
the economy are facing headwinds.
Corporate defaults are set to increase, even in a soft-landing scenario.
• High levels of dispersion create opportunities for active managers to outperform.
• The signposts that could encourage us to be more bullish is core inflation to meaningfully fall,
broad money to pick up and China and EM easing.
25 April 2023, London – All credit risk indicators have remained flashing red with access to capital
deteriorating and earnings set to weaken, according to the latest analysis from Janus Henderson
Investors. The credit cycle has and will continue to move lower over the coming months, with further
volatility in credit spreads. Security selection will remain critical as defaults start to rise.
Janus Henderson Investors’ latest Credit Risk Monitor tracks corporate fundamental and
macroeconomic indicators on a traffic light system to indicate where we are in the credit cycle and how
to position portfolios accordingly. The key indicators tracked (‘Cashflow and Earnings’, ‘Debt Loads and
Servicing’, and ‘Access to Capital Markets’) all remain red.
Jim Cielinski, Global Head of Fixed Income at Janus Henderson Investors, said:
“Recent market volatility was concentrated on interest rates rather than the wider credit market itself.
While certain sectors, such as banking, came under pressure, the change in rate rise expectations
buffeted markets. The ramifications of tightening monetary policy were inevitably going to cause parts
of the financial system to bend or break and the first casualty was the weakest parts of the banking
system. We are at an inflection point where we could see a turn in the credit cycle. The signposts we
are looking for to become more positive are core inflation to be meaningfully below 4-5%, broad money
to start to bottom and pick up and China and EM easing, providing a tailwind for global growth.”
‘Access to Capital Markets’
Spotlight on lending standards will further tighten credit conditions and will hit GDP
The recent banking crisis has exacerbated the trend towards tighter credit, but lending criteria has been
tightening for the past nine months already. It does bring forward the likely recession though.
As tighter credit conditions could depress US GDP by three or four tenths of a percentage which,
although small overall, could do damage to rate sensitive parts of the economy such as real estate,
banking, and certain parts of the durable goods sector.
‘Debt Loads and Servicing’
Defaults have bottomed but they are about rise
Corporate credit defaults have been virtually non-existent for the past two to three years, but this is
about to change. A lagging indicator, the default picture will worsen from here. The extent of the damage
will be dependent on whether the Central Bank navigates a hard or soft landing in its attempts to
manage inflation. A softer landing, combined with a peak in defaults over the next six months which
then rolls over, is the most likely outcome currently priced into spreads.
As the market anticipates higher defaults, companies that are exposed to refinancing risks and higher
rates will struggle, but much of the corporate market is well insulated from any economic outcome,
aside from a deep ‘hard landing’. As defaults tick up, security selection becomes even more critical.
‘Cashflow and Earnings’
Exogenous shock to cash flow are still filtering through
Earnings continued to be revised down, with no or negative earnings growth expected in 2023 across
developed and emerging economies except for the eurozone, China and Japan. A ‘hard landing’
recession would be the most painful, but even a medium recession would be enough to dent many
companies’ balance sheets. Spreads are currently pricing in a ‘soft or shallow landing’. This is still
possible but, until there is confirming evidence that the credit cycle has turned, JHI’s credit team remain
cautious on credit spreads.
Asset Allocation Implications
Dispersion is expected across rating quality, sectors and geographies
In the face of one of the fastest and most aggressive rate hiking cycles, the US has emerged broadly
unscathed as its economy is less sensitive to rising rates. Many people have mortgages which are
locked in at 2-3%; full employment means many have steady, reliable income; and nominal growth has
been strong.
That protection is less in regions like the UK and Europe where there is more floating rate debt, floating
rate mortgages and inflation has hit household incomes harder.
At a global level, China and emerging markets are the first regions to begin easing monetary policy
which could catalyse global growth. We anticipate a rolling recession across sectors and geographies.
Jim Cielinski added:
“When you look at what drives value toward the end of recessions, this time is unlikely to be any different
to previous cycles. Through careful security selection, investors can capitalise on the extreme amounts
of dispersion in markets. The weakest players often feel severe pain as they fall by the wayside and
default. But the result is that you emerge on the other side with easier monetary conditions, coupled
with stronger companies who are behaving cautiously and looking to deleverage their balance sheet.
The banking sector was a great example of this. Picking the winners and the losers is even more critical
towards the end of a credit cycle.”
