Credit markets have staged an epic rebound from the depths of March 2020. But in a low-growth, low-yield world, we believe there may be more room to run in 2021.

The COVID-19 pandemic has had tragic results for humanity and has hammered businesses globally. Widespread lockdowns and travel bans have wiped out earnings for many industries worldwide, and developed-market economies may not regain fourth-quarter 2019 real GDP levels until 2022. That’s a sobering picture. But for global credit markets, as we look forward into 2021, we see several factors that will likely prove positive.

Of course, the path to economic recovery will be bumpy and uneven. For investors, we believe a nimble, selective approach will be especially important to grasp the opportunities presented by an evolving corporate debt landscape.

Coronavirus Pandemic Reshapes Credit Markets

Enforced lockdowns have triggered an increase in the level of credit defaults and led to a wave of rating downgrades from investment-grade to high-yield status. This has changed the structure of credit markets, removing the weakest borrowers from both investment grade and high yield, while increasing the quality, size and depth of the high-yield market. Both markets are healthier for it and present opportunities across the credit spectrum for investors searching for the optimal balance.

The migration of “fallen angels” out of investment grade has materially increased the size of US and European high-yield markets, by around US$200 billion and €50 billion respectively. These fallen angels include some of the best-known and widely respected names in the business world, including Ford, Rolls-Royce and Carnival.

Their arrival has significantly improved the overall quality of the high-yield index, increasing the share of BB-rated credits in the US from around 48% pre-COVID-19 to 54% (Display, below). In Europe, this new influx of debt also adds depth to the market and consists mainly of “non-callable” bonds which cannot be redeemed early by the issuer. These factors are attractive to longer-term investors such as pension funds and insurance companies, and so increase the demand for high-yield assets.

At December 31, 2020 the US High-Yield Market’s BB allocation was 6% higher than 2019 and 10% more than the 10-year average.