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The global credit cycle appears to be in recovery after swift progress through the downturn and credit repair phases. Here, we share our analysis of the credit cycle and key factors we’re watching.

WHAT IS THE CYCLE TELLING US? 

We use the table below to track important indicators of the credit cycle. The majority of signals are now consistent with the recovery phase of the credit cycle, especially when incorporating our forward-looking views.

CreditCycleTable_01-26-21

WHAT ARE WE WATCHING?

The table above tracks the most significant indicators of the credit cycle. However, we’re also watching factors specific to current circumstances that might influence progress through the cycle. In our view, no individual variable is likely to single-handedly shift the cycle, but it may ignite a chain of developments that ultimately rotates the cycle. Here’s a snapshot of these special factors:Macro Credit Cycle Graphic - 10.2.2020-1Macro Credit Cycle Chart_01.27.21Macro Credit Cycle Graphic - 10.2.2020

WHAT CAN WE EXPECT FROM THE RECOVERY PHASE OF THE CYCLE?

Here are common themes typical of recovery:

  • Profits typically grow faster than debt, and defaults usually peak.
  • Corporate deleveraging should be well underway, especially as asset prices rebound.
  • Credit spreads tend to move tighter and equities start to outperform.
  • Risk appetite continues to improve as economic and profit growth become stronger.
  • Lending standards ease, and credit supply improves.
  • Asset prices typically get bid up with liquidity generated from increased credit and profit growth.

Importantly, we do not expect a smooth path through recovery. Surging COVID-19 cases worldwide will likely moderate the pace of growth in the months ahead. However, with vaccines rolling out and a second round of US fiscal support, we believe markets will look through short-term disruptions.

Several economic indicators support our positive view of the recovery:

  • The aggregate health of the US consumer appears strong, with $1.25 trillion of excess savings compared to pre-pandemic levels.1
  • We have a solid outlook for the housing market, which has made a striking recovery from the lows reached in the spring of 2020. Strong demand and historically low mortgage rates have led to a significant resurgence of order growth for new homes, existing homes and continued home price appreciation.
  • We expect many goods providers to begin rebuilding inventory levels.
  • Even the small business sector appears to be holding up, thanks in large part to the fiscal support it has received thus far. Small business confidence and hiring intentions have sharply recovered from spring 2020 lows.2

Together, we believe these factors could create a powerful engine for the recovery when we exit pandemic conditions. If social distancing begins to lift in late spring 2021, we believe global GDP could reach its 4Q 2019 peak sometime in late 2021 or early 2022.

 

READ ON FOR A SNAPSHOT OF OUR VIEWS ON KEY TOPICS RELATED TO RECOVERY 

COVID-19

OUR VIEW: Vaccine distribution should keep us on track to begin easing social distancing by summer 2021.

THE DETAILS: COVID-19 cases in Europe and the US continue to rise, which could slow the recovery. The mutation of the COVID-19 virus is concerning for current hospital capacity, but we believe the vaccines will remain effective against the virus. We expect vaccine distribution to accelerate in coming months, and social distancing measures could begin to ease by summer 2021.

Global Growth

OUR VIEW: Expectations for vaccine distribution and herd immunity support a strong outlook for global growth in 2021.

THE DETAILS: The recovery in global growth may be tempered in the near term as major economies try to contain the spread of COVID-19. However, we believe US fiscal support, monetary policy support and pent-up demand could feed a strong recovery once social distancing measures begin to lift.

Fiscal Policy

OUR VIEW: We anticipate a push for further fiscal relief in Q1 2021.

THE DETAILS: With many emergency benefits set to expire before the end of March, we expect Congress to pass another fiscal package in the range of $500 million to $1 trillion. We expect the Biden administration to begin working on his larger agenda of spending and tax measures, which could pass through the budget reconciliation process in late 2021 or early 2022.

US Corporate Profits

OUR VIEW: We expect profit growth to potentially exceed 20% in 2021.

THE DETAILS: We believe profit growth is on track to reach its 2019 peak in 2021. Key supports include easy monetary policy, fiscal stimulus, solid consumer balance sheets, vaccine distribution and rebounding economic activity.

US Corporate Leverage

OUR VIEW: We expect companies to pursue genuine deleveraging, where profit growth exceeds debt growth and the debt-to-profits ratio declines.

THE DETAILS: We are not yet seeing companies actively deleverage. Profits are just starting to bounce back, but it is early days. Once profits and incomes sustain a rebound, we expect to see more deleveraging efforts. Companies will typically shift their focus from financial engineering to fixing their balance sheets. Of course, the defaults we’ve seen are another form of deleveraging, but it is much healthier to lower the debt-to-profits ratio.

Global Credit Risk Premium/Risk Appetite

OUR VIEW: Credit spreads have retraced much of the March selloff, but we see room for additional tightening over the next six months.

THE DETAILS: Credit spreads appear well supported as profits continue to bounce back and monetary policy remains easy. Markets appear to be looking forward to the gradual lifting of social distancing beginning in mid-2021. A major vaccine-related setback could be a headwind for the markets.

Global Inflation

OUR VIEW: We see limited inflation pressure in the near term, but it may start to rise later in 2021.

THE DETAILS: We believe output gaps, social distancing, and further virus spread should limit inflationary pressure in the near term, but it could rise with demand if pandemic conditions lift later this year. We expect central major banks to tolerate a modest rise in inflation without tightening.

The Dollar

OUR VIEW: We anticipate limited weakness in the dollar.

THE DETAILS: We expect strong risk appetite to drive the dollar modestly weaker. However, we’re not calling for a multi-year dollar bear market. Once the initial economic rebound is over, we expect US growth prospects to outpace other global developed markets.

Endnotes

1Source: Bureau of Economic Analysis NIPA Tables, Q3 2020.

2Source: National Federation of Independent Business.
 
 
Disclosure
 
Views as of January 26, 2021. The chart presented above is shown for illustrative purposes only. Some or all of the information on this chart may be dated, and, therefore, should not be the basis to purchase or sell any securities. The information is not intended to represent any actual portfolio.

This material is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein, reflect the subjective judgments and assumptions of the authors only, and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis does not represent the actual, or expected future performance of any investment product. Information, including that obtained from outside sources, is believed to be correct, but Loomis cannot guarantee its accuracy. This information is subject to change at any time without notice.

Indices are unmanaged and do not incur fees. It is not possible to invest directly in an index.

Past market experience is no guarantee of future results.

LS Loomis | Sayles is a trademark of Loomis, Sayles & Company, L.P. registered in the US Patent and Trademark Office.

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