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July 2021 | Issue 236
Opinion Credit
Pain is on the way: spreads are too tight, while compression and carry are done. But what if it’s not?
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Welshcake reminds us that mid-cycle portfolio management is a funny old game
It’s half time and everything is finely poised. You sit there knowing in all likelihood this is going to play out to a stalemate, but it’s guaranteed to be far from without incident and you can’t take your eyes from the screen even for a second in case you miss something crucial.
Yes, the credit market is an exciting place in 2021, despite its lack of direction. But UEFA’s Euro 2020 championship has also had its moments.

You might imagine I’m sour about Wales going out, but not at all. Congratulations to Denmark on booking their quarter final place — though there was less than an unconverted try score in it. We Welsh can stand proud, what with football being only one of the nation’s lesser participated sports behind rugby union, rugby league, golf, snooker, darts, horse-racing, cnapan, bando and pêl llaw.
I’ll just point out that, in the group stages, Wales drew 1-1 with Switzerland, the mighty footballing force that thrashed France on penalties. And given we also exited the competition in the same round as the reigning world champions (and the European champions Portugal), it’s beyond dispute Wales would be by far the best team in Europe if we actually practiced.
In all seriousness, Wales’s approach was one of the more tactically naive I’ve witnessed in recent times. Enthusiastic and decidedly have-a-go, the team were rarely in control. In these times of ultra-low market volatility, it made me think of when a trading strategy predicated on deeply out-of-the-money options expires (except Wales would lose the ball in less than 20 seconds). Now and then a player might complete a pass to another, but it didn’t happen often enough to convince me I wasn’t watching some Monte Carlo simulation.
Anyway, I am free again to devote myself to credit. Well, that and repeat-watching of Dream Horse, a film about how a Welsh bartender bred a steed that competed in the Grand National (which is better than thinking about England).
The market message that’s been hammered away in recent weeks is that pain is on the way: that spreads are too tight, that compression and carry are done as profitable trades, that hedges are needed against inflation, and volatility is going to resurface and wipe out any ­meagre gains you might otherwise have made. It’s just a question of when the end will come — with many expecting it as soon as August or September.
But let me, with all my Welsh naivety, pose the question a different way: what if it doesn’t?
Fear of missing out can be a terrible siren call, but there is still a lot to miss out on in the second half. Most indicators suggest we’re mid-cycle, and that being the case returns will be lower but more stable than those enjoyed in the early part of the cycle. This part also tends to last longer.
The lack of accord between credit specialists on the best areas of focus and inherent risks is another sure sign we reside in a time of opportunity. Variously I hear high yield has reached a point of vulnerability, but also that fallen angels are due for resurgence to investment grade. The problem will either be a systemic bout led by central banks, or it will be idiosyncratic. Index equity tranches are either a must-buy or a poisoned chalice. Some warn about a short-end spike in rates and see the greatest value in long-dated triple B credits, while others avow these will be first hit if the US Federal Reserve turns hawkish. And then there’s the broader argument to eschew bonds altogether in favour of loans, given they are playing catch up and offer resistance against inflation.
Markets may remain benign for some time
I’m not arguing here for one view or another on ratings bands, curves, geography or even asset class — although betting against CLOs as a buyer base feels particularly foolhardy. The bigger observation is simply that the market’s wariness about all things feels overdone. It has left positioning very light and this in itself makes those who are invested less susceptible to shocks.
Add to this the summer slowdown and we could be looking at a benign run for some while. Of course, the lack of primary action makes going long harder for you cash credit aficionados, but you only have to look to grinding CDS indices to see how there is room to add risk.
All of which adds up to a unifying axiom: however you decide to play in this contest, do not be in a rush to get out too early. Just ask Wales.
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Global credit funds & CLO's
July 2021 | Issue 236
Published in London & New York.
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