Our Head of Corporate Credit Research Andrew Sheets discusses why
uncertainty around the election’s outcome could be detrimental
for credit investors.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of
Corporate Credit Research at Morgan Stanley. Along with my
colleagues bringing you a variety of perspectives, today I'll
discuss the US Election, and how it might matter for
Credit.
It's Friday, October 18th, at 4pm in London.
Morgan Stanley’s positive view on credit this year has been
anchored on a simplistic thesis. Credit is an asset class that
hates extremes, as it faces losses if a company fails, but
doesn’t earn extra if that company’s profits double or even
triple. Credit, to an unusual degree, is an asset class that
loves moderation.
And here at Morgan Stanley, we’ve been forecasting … a lot of
moderation. Moderate growth for the U.S. and Europe. Moderating
inflation, that continues to fall into next year. And a
moderation of central bank interest rates, rather than the type
of sharp declines that you tend to see around recessions; as we
think Fed funds will settle in a little bit below
three-and-a-half per cent by the middle of next year. This
moderate economy, coupled with moderate levels of corporate
aggressiveness should be music to a credit investor’s ears, and
support richer-than-average valuations, in our view.
So how does the upcoming U.S. election on November 5th fit into
this otherwise benign picture?
Who runs a government matters, especially when it’s the
government of the world’s largest and strongest economy. This
election is also notable for the differences between the two
candidates, who are presenting sharply contrasting visions of
economic, domestic and foreign policy. Against this backdrop, we
suggest credit investors try to keep a few things top of
mind.
First, and most broadly, the idea that “credit likes moderation”
remains our north star. Outcomes that could drive larger changes
of economic policy, or larger uncertainty in policy in general,
are probably going to be a larger risk for credit.
Second, of all the various policies under discussion, tariffs
feel especially important as they can be largely implemented
without congressional approval, and are thus far easier to see go
into effect. Tariff proposals could create significant dispersion
at the single-name level in credit, and pose significant risks
for sectors like retail, which import a large share of their
ultimate goods. For time-limited investors, tariffs are the
policy area where we’d spend the most time – and where much of
our Credit Research around the election has been focused.
Third, it’s notable that as we head into this election, expected
volatility, in equities or credit, is elevated even as the stock
market sits near all time highs, and credit spreads are
historically low. So this begs the question. Do these options
markets know something that the rest of the market does not?
We’re skeptical. Historically, when you’ve seen high volatility
alongside all-time-highs in the market – and it’s not all that
common – it’s tended to be a positive short-term indicator,
rather than a negative one. And one way we could perhaps explain
this is that it suggests that investors are still a little bit
nervous, and not as positive as they otherwise could be.
The U.S. election is close in time, uncertain in outcome, and
has stakes for future policy. That high implied volatility
we see at the moment, in our view, could reflect known unknowns,
rather than some hidden factor. Tariff policy, being largely
independent of congress and thus easier to implement, is probably
the most relevant for single-name credit exposures. And most
broadly, credit likes moderation, and should do best in outcomes
that are more likely to achieve that.
Thanks for listening. If you enjoy the show, please leave us a
review wherever you listen and share Thoughts on the Market with
a friend or colleague today.
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