Michael McKenzie from London
Central banks have already risen to the challenge this year through monetary policy easing significantly. The rise in global stock prices in October shows investors are buying.
Standard-cut interest rates was not the only catalyst; the Fed re-launch the process of expanding its balance sheet, the ECB revised its program to buy bonds, both of which maintain the flow of liquidity to the financial system.
This makes life difficult for pessimists who are still unable to enjoy their moment, despite the slowdown in earnings growth of large US and European companies, and despite warning signals about earnings expectations for 2020. Dividends may not be an important part of the optimists' argument. To prefer stocks over fixed, low-interest rate yields offered by bonds - as strong as expected.
The next economic downturn could easily lead to a wave of downgrades of lower-grade bonds in the investment-grade world as they fall into a speculative market that lacks the scope to absorb large amounts of bonds smoothly.
The importance of bonds to the broader financial system and investment portfolios is becoming more established a decade after the global financial crisis. The credit panic in 2015 and 2016, stimulated by China by stirring a sharp drop in commodity prices, in which oil played a prominent role, and then late last year when the Fed tightening led to a sharp rise in real yields, was a harbinger of financial markets.
Certainly, the current atmosphere in the US credit markets calls for surveillance, particularly the risky CCC bonds and the $ 1.15 trillion leverage market. The weaker performance in the higher leveraged credit world comes during a period of strong performance for other risky assets in general. There is a strong possibility that the pessimists are wrong and that this market offers a great buying opportunity if the Fed is right, we are moving with moderate growth, and no further easing is needed in 2020.
The impetus for avoiding CCC-rated bonds is illustrated by the fact that about 45 percent of the bonds in the sector are in default, according to Bank of America Merrill Lynch, reflecting the heavyweight on troubled energy companies. Caution has prompted some investors to jump from one of the ratings to a category B that is somewhat safer, but the return remains somewhat dear.
Optimistic views on stocks depend on a corporate bond market that anticipates a smooth movement and suggests that the risk of a deeper economic downturn is exaggerated. But there is an argument that falling US Treasury yields, which in turn are affected by the huge amount of global negative yields, have alleviated the pain signals from the credit market.
This highlights on how the relationship between the bond inflation with BBB and with the credit rating B credit rating investment grade, which is of the highest quality in the high-yielding sector, fell to levels seen in 2007 and 2005 as well as in 2001, just before the fade dangerous atmosphere of the market.
Should not be ruled out a sudden and clear decline in bond prices, the potential catalyst for such a move is the economic data that show divisions among consumers. What should be of concern to bond investors and overshadow stocks is the weaker economic activity scenario that will derail the recovery in corporate profit growth and go beyond the mild result of central bank liquidity and cheap borrowing costs.
Market sentiment and the positions taken by investors in the bond market reflect expectations of a mid-cycle slowdown that will ease in 2020. But the long-term concern is that such an outcome only delays an inevitable wave of lowering the level of leverage of debt-burdened companies.