Supply chains and labour shortages
The impact of broken and strained supply chains remains a key risk to the economic outlook. The failure of once-reliable supply chains – that took decades to construct – to self-correct could result in a breakdown of manufacturing cost structures as businesses invest to rebuild more reliable supply chains. The longer this triaging process takes to play out, the more extended ongoing price pressures and volume-related revenue declines across multiple sectors could be.
Labour shortage is another major source of uncertainty for the outlook, which will likely have the longest residual impact on inflation figures and, ultimately, central bank actions. Worker availability is at acute levels, exacerbated by demographics and immigration policies, as a decline in working age continues amongst an ageing population. Anti-immigration politics have been big issues in the US and UK for years. Assuming this doesn’t change meaningfully, the most likely solution to the labour shortage is higher wages, which could in turn impact inflation and result in central bank reaction.
The key related risk for credit investors is the impact on individual companies – with some business undoubtedly more exposed than others. In this vein, individual credit selection will be key in attempting to avoid the most exposed corporates.
Geopolitical tensions simmering
Rising tensions are bubbling up to the surface on several large-scale geopolitical fronts, any one of which could have a very damaging impact on economies and markets if mismanaged – whether that be between Russia and Ukraine, the US and China, China and Taiwan, or even through the pivot in internal Chinese economic policy. Properly quantifying such risks is exceptionally difficult and we believe bottom-up selectivity remains key to avoiding credit exposure at the epicentre of these geopolitical flare ups.
In this environment, how do credit investors position themselves?
While the recent volatility has seen a modest repricing in certain credit markets, we believe the uncertain outlook will require strong investment discipline and active use of the full opportunity set in order to maximize returns. We believe attractive carry is still on offer, but now is the time to be particularly discerning when investing in any credits particularly exposed to the above risk factors. Whilst ever evolving depending on market conditions and individual opportunities, our positioning has generally been to increase floating rate and short duration exposure, taking advantage of relatively flat credit curves and attractive carry in those parts of the market. We have also been reducing traditional call constrained high yield and rotating into more defensive carry implements such as CLO’s and short duration bank capital.
In Conclusion
While 2020 and 2021 was about dynamically allocating across global credit markets to best capture the rally, we believe the focus in 2022 will be about strong credit selection and shrewd portfolio construction. While attractive pockets of opportunity still exist within credit markets, we believe that as some of the above risk factors play out, there will be good opportunity for the dynamic credit investor with a broad opportunity set to take advantage of the resultant volatility.
