Casting Credit: The risks facing US credit and equities in 2024

Credit events 

There is always the chance of a credit event. Regional banks have been in the spotlight over the last year, largely because of their exposure to commercial real estate (CRE) and, particularly, the office building market. I discussed this with our real estate team and economists this week and we came to the conclusion that CRE is a problem, albeit one with limited scope. The impact on larger banks is negligible given the amount of provisioning set aside for credit issues. Still, another regional bank issue related to CRE could have a negative impact on investor sentiment and could force the Fed to re-introduce liquidity tools. A shock and a central bank response would likely mean wider spreads, at least for a while.

Risk-off 

Evidence of slower growth, a Fed reluctant to ease, sticky service sector inflation, some more bad news on commercial real estate and the uncertainties around what will happen after the US Presidential election could all contribute to a negative shift in risk appetite. Credit is quite expensive in the US. Equities are expensive too. Using consensus earnings estimates for 2025, the S&P 500 is trading on a multiple of 19 times. This is just below the recent peak of 20 times in 2021 when multiples expanded during the post-pandemic recovery. Few would be surprised if the stock market went through a period of adjustment, especially as much of the total return performance has been driven by a mere handful of technology stocks over the last year.

But carry is strong 

All of the above are risks but, for now, they are not material enough to reverse positive momentum in markets. There is no recession, rates will probably come down in the second half of the year and companies are doing very well. Europe is weaker but lower rates should help, and the forecasts from the UK’s Office for Budgetary Responsibility, presented alongside this week’s fiscal Budget, are more positive. Any setback in markets should potentially be seen as an opportunity to invest (buy on dips). Given where yields are, carry will remain an important driver of total return in credit markets.

Better macro, fewer rate cuts 

There’s another quarter to go before the market is expecting rates to be cut in the US and Europe. We have time to assess how markets are likely to respond. If it is a gentle easing against a backdrop of positive global growth, then bond returns are likely to be close to current yield levels (mid-single digits) and equities can still deliver something close to expected earnings growth (low double digits). While some might clamour for more rapid rate cuts, the likelihood is that if that were to happen, the macro backdrop would be much worse and thus, much worse for credit and equities. A Fed having to ease in and around a contentious Presidential election campaign would not be a favourable investment climate. The rest of the year is going to be interesting, but for now, stay with credit. 

(Performance data/data sources: Refinitiv DataStream, Bloomberg, as of 6 March 2024, unless otherwise stated). Past performance should not be seen as a guide to future returns.