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The global credit cycle appears to be early in the expansion phase. Global growth has picked up and risk appetite remains strong. Here, we share our analysis of the credit cycle and key factors we’re watching.

 

Where is the cycle headed?

Many of the signals we anticipate on a forward-looking basis appear consistent with the expansion phase of the credit cycle. We expect economic growth to remain solid, though the pace of economic growth will likely peak in the months ahead. We believe the US Federal Reserve and other central banks will gradually wind down emergency measures as inflationary pressures start to build and risk appetite in some segments of the market becomes frothy.

 

  DOWNTURN CREDIT REPAIR RECOVERY EXPANSION 

ECONOMIC GROWTH

Weak - Deteriorating Weak - Stabilizing Strong - Improving Very Strong - Peaking

CREDIT GROWTH

Declining Low Accelerating High
CENTRAL BANK POLICY Easing Easy Starting to Tighten Tightening - Policy Errors

INFLATION PRESSURE

High - Breaking Lower Low - Stabilizing Moderate - Rising High - Rising
VOLATILITY Above Average - Rising Above Average - Falling Below Average - Stable Below Average - Rising
RISK APPETITE Low Low - Improving High High  - Irrational
LIQUIDITY Low Improving - High  High Declining
YIELD CURVE Steepening Steep Flattening Flat - Inverted
FUNDAMENTALS Profit Contraction Debt Contraction Profit Growth > Debt Growth Debt Growth > Profit Growth
ASSET VALUATIONS Falling to Below Average Below Average - Rising Near Average - Rising Above Average - Rising
CREDIT VS EQUITY Credit & Equity Both Down Credit Preferred Credit & Equity Both Up Equity Preferred

Source: Loomis Sayles, as of 4 June 2021. Highlighted cells represent attributes we anticipate on a forward-looking basis. Black represents attributes typical of downturn, navy blue represents attributes typical of credit repair, bright blue represents attributes typical of recovery, and light blue represents attributes typical of expansion.

What can we expect as we progress through the cycle?

This is an unusual cycle in terms of speed. Employment in many countries remains far below pre-pandemic levels, which would normally suggest recovery. However, massive job and economic gains have facilitated a quick transition into expansion. We expect further progress as more countries open up in the months ahead.


Themes to watch as the cycle progresses through expansion:

  • Shareholder-friendly corporate behavior.
  • The profit boom begins to fade, and debt growth starts to accelerate.
  • Risk appetite remains strong.
  • Central banks begin to reverse easy monetary policies.
  • Credit spreads reach expensive valuations while equities climb higher.

We believe the US is further along in the credit cycle than the rest of the world, largely because of its swift COVID-19 vaccination progress and large injections of fiscal stimulus. Lagging vaccine distribution in other countries has left many economies playing catch-up.

We see three scenarios for the expansion phase, based on how this divergence in growth plays out.

Our base case: Assumes that growth in the rest of the world gradually catches up with the US by the end of 2021, leading to a strong global expansion.

Our bull case: Assumes the rest of the world catches up quickly, keeping pace with or even outperforming US growth. Meanwhile, the Fed and other central banks maintain super-low interest rates as they wait for inflation to remain sustainably above target (most countries have an inflation target of at least 2.0%).

Our bear case: Assumes US growth accelerates so quickly that the Fed pulls forward rate hike expectations, shocking the markets and denting global risk appetite.

base-casesmall

 

Here’s a quick comparison of the three expansion scenarios:

  BOOM EXPANSION
(Bull Case)
EXPANSION
(Base Case)
DISRUPTIVE EXPANSION
(Bear Case)
GLOBAL GROWTH Synchronized US leads, rest of the world catches up Uneven
US INFLATION Meets Fed's 2% target Gradually reaches Fed's 2% target Overshoots Fed's 2% target
YIELDS Rise at healthy pace Rise gradually Surge higher
RISK APPETITE Remains healthy Remains healthy Dented
FED RATE HIKE EXPECTATIONS Early 2024 Early 2023 Pulled forward to 2022
US DOLLAR VIEW Weaker Trend weaker Stronger

We place the highest odds on our base case scenario, an expansion with the US leading and the rest of the world slowly catching up by the end of 2021. Combined with a slower pace of rising yields, we believe growth dynamics should continue to support credit spreads and riskier assets.

Our views on key topics that can influence the credit cycle

COVID-19

OUR VIEW: We expect COVID-19-related hospitalizations and deaths to trend lower as vaccinations pick up pace around the globe.

THE DETAILS: We believe markets will shrug off the spread of more transmissible COVID-19 variants as long as vaccines remain effective and vaccination rates continue to pick up. We are watching the number of COVID-19-related hospitalizations and deaths rather than the number of cases. We view Israel as a good indicator of what to expect—it has the largest percentage of vaccinated residents and hospitalizations, and deaths are currently declining.

Global Growth

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

THE DETAILS: Our growth expectations are based on successful COVID-19 vaccine distribution. Uneven vaccination rates in different economies have led to diverging growth rates around the world. We expect lagging economies to ramp up their vaccine efforts in the coming months, leading to more synchronized global growth.

Fiscal Policy

OUR VIEW: More US fiscal spending is likely to come. Other countries have more limited fiscal capacity.

THE DETAILS: The Biden administration has proposed an ambitious plan to expand jobs and improve infrastructure. The big question is how the US government will pay for infrastructure and other spending—will it run persistent deficits or match spending goals with revenue raised from taxes?

Europe is still digesting its landmark jointly funded €750 billion fiscal plan. In other major countries, fiscal policy has been more constrained, especially in emerging markets. We are concerned that a fiscal risk premium is keeping emerging market exchange rates cheap compared to the rise in commodity prices.

US Corporate Profits

OUR VIEW: Consensus estimates for corporate profits have been rising, but we think upside surprises are likely. We see potential for year-over-year profit growth to reach around 35% this year.

THE DETAILS: Consumers have not been holding back on spending. We expect an all-inclusive rebound in corporate earnings, from growth to value sectors. Above-average earnings-per-share growth is likely to continue in 2022, though at a less robust rate around 10%. We think President Biden’s tax plans will get watered down to some extent and should not cause a major disruption in the markets.

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: The profit surge has begun, and so far, it has beaten consensus forecasts. Having profits exceed debt growth is an easy way to deleverage. We expect this trend to continue, leading to more upgrades in credit ratings. There is a risk that corporate managers shift to late-cycle behavior and take on more risk to maximize equity returns, leading to higher earnings volatility. We believe this would increase the risk of downgrades and defaults.

Global Credit Risk Premium/Risk Appetite

OUR VIEW: We think risk appetite can remain strong despite credit spreads grinding lower and equities hitting new highs.

THE DETAILS: Our position in the credit cycle (early expansion) typically offers favorable conditions for taking risk. Credit spreads appear well supported as profits bounce back and fiscal policy remains easy. Spreads have not flinched in the face of higher yields. We would view near-term weakness as a buying opportunity.

Global Inflation

OUR VIEW: We expect global inflation to drift higher given the cyclical upturn.

THE DETAILS: Central banks have vowed to look through significant jumps in year-over-year inflation due to base effects in the second quarter. We expect global inflation to return to trend levels in the second half of 2021 and gradually move higher as economies normalize. We expect major central banks to tolerate a modest rise in inflation without tightening.

The Dollar

OUR VIEW: We think the primary trend of the dollar is lower.

THE DETAILS: Growth and interest rate differentials are likely to remain in favor of the dollar near term, but we believe the dollar is likely to drift lower as the global economy catches up to the US. A weak dollar helps to export US reflation efforts around the world, supporting global growth. That is why we consider the dollar a pro-cyclical currency.

Views as of 4 June 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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