October Update: Debt crisis gives credit managers globally plenty to work with
A very close result in terms of the overall U.S. election, in what was probably the most expensive presidential election ever, but the current President managed to stay elected—no mean feat with unemployment at 8%. Evidently he is not entirely blamed for sluggish economic growth and still-large deficits. Attention has now turned to the politically divisive “fiscal cliff”, which promises a crisis-like run in to year-end. The deadline looms for some $600 billion of automatic spending cuts and tax increases unless a sharply divided Congress finds compromise.
No doubt a deal of some sort will be found, though it is difficult to imagine what exactly. With U.S. interest rates pinned near zero across the maturity curve by Fed policy, markets are not yet applying pressure for a long-term solution—perhaps because everywhere else looks worse. Looking beyond the current record deficits lies the even bigger problem of unfunded entitlement spending. For investors, this begs the question: when will interest rates eventually normalize? Not just rise back above today’s headline rate of inflation but also reflect expectations of inflation. This sort of language has not been used in mainstream media since the first Reagan administration (when your scribe was in business school) but also when interest rates last peaked.
It may be years still before inflation is viewed as “the” problem but in no way is this priced into current asset prices. Except perhaps in the shortage of inflation-linked bonds in some markets, such as the U.K. In our view, getting through today’s markets will seem easy compared to one day dealing with a U.S. Treasury market featuring yields that rise for an extended period of time. Not just for a couple of quarters, but a decade or two.
We suggest one of the better core investment choices today is a well-selected and well-hedged credit book. One benefit of the Eurozone crisis is the now-large size of Europe’s high yield bond market, though most of these were not issued as such. Along with big, deep U.S. credit markets, active credit managers globally have plenty to work with.