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Credit: Mispricing presents attractive entry points in 2023

‘A look ahead to 2023’ download our full report below

2022 has been the year where the global bond markets have finally woken up to the reality of central banks’ stimulus being removed from the bond markets. Add to this the reality of persistent higher inflation, geopolitical risk, and increased probability of recession and there has been an unpleasant cocktail of higher bond yields and widening credit spreads.

Freefall and contagion

Yields and credit spreads in sterling corporate bonds have been particularly elevated in the latter half of the year as the gilt market reacted to the disastrous unfunded ‘mini budget’. Gilts went into freefall and there was contagion to corporate bonds as forced sellers scrambled to sell corporate bonds to raise liquidity against collateral calls on LDI (Liability Driven Investment)
strategies. A change in the UK government and complete U-turn in the Autumn Statement from giveaways to prudence regained some sense of credibility for the government and helped markets to stabilise. In addition, the widening of credit spreads relative to overseas markets led to a number of real money investors revisiting the valuation of sterling corporate bonds.

Longer term opportunities

As is often the case, short term volatility can create many longer-term opportunities. We end the year with expectations that the central banks terminal rates may not be as high as previously factored in and the market is adjusting by pricing in an increased expectation of central banks pivoting. Credit spreads are also pricing in recession risk (correctly in our view) but are factoring
in too high implied default probabilities with associated ratings migrations and defaults, particularly in the investment grade space.

Many sectors are fundamentally mispricing the default risk, for example non-cyclical consumers which are likely to remain resilient in a recession and banks which have lower level of impairments and higher capital buffers than in previous economic cycles.

We believe this mispricing in certain sectors and companies has presented investors with an attractive entry point for credit and a positive outlook for the year ahead.

Justin Hatch, Head of Credit

In 2023, we expect defaults to rise, but feel there is relative value in investment grade
compared to high yield, so it will be more important than ever at this part of the economic cycle to have an indepth oversight of credits.

Clear oversight of credit fundamentals

Consequently, we feel that the longer-term investor will be well compensated for buying corporate bonds versus government bonds. We expect volatility to remain but within narrower trading ranges than we have seen this year, and both absolute yields and relative spreads
(excess yield over government bonds) look attractive. We believe that buy and maintain strategies with a clear oversight of credit fundamentals for companies and sector exposures will pay dividends for the longer-term investor and are positive for the outlook for 2023.

A look ahead to 2023

A year of reflection, consolidation and strategies.

A look ahead to 2023

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