Credit Check: Lessons, Losses and Hot Takes

(upbeat music) - Welcome to No More Risk Better, a credit sites podcast. Across the global strategy team, we aim to make sense of the macro and the micro, highlighting opportunities and the risks facing the fixed income markets. - As the macro makes headlines, we leverage our network of experts across fixed solutions to better understand economic trends, rates, gyrations, geopolitical events, and how these factors impact corporates. - At Credit Sites, we understand that credit investing comes down to picking winners to generate alpha and avoiding losers. Our team of over 100 analysts across the US, Europe and Asia provide unmatched sector expertise and fundamental knowledge. - In our weekly podcast, the strategy team offers a look at the conversations we have with our colleagues, including analysts, fellow strategists, economists, and leverage finance market experts. If you want to know more so that you can risk better, you'll want to give this podcast a listen. - Hello, everyone. And welcome back to the last Credit Sites. No more risk better podcast episode of 2025. The year that we'll go down is the one where I feel like I aged about 10 years. So that's how we're setting the scene for today. This is when he sees our global head of strategy at Credit Sites. And I have with me my right-hand man, the person who has seen the ups and downs of my roller coaster of market-related emotion, Zach Griffiths, our head of US investment grade and macro strategy. Zach, thank you as always for really everything. - I'm looking forward to bringing it home on the strong note here, Winnie. - All right, a strong note I hope we can definitely have. So Zach, we today are going to talk about 2025, our lessons learned, and maybe some hot takes, especially heading into 2026. So Zach, I'm going to open with a question about the moment, the defining moment of 2025. What was it for you that made you completely rethink your investment thesis? - So I can't pick an exact moment, but when I go back and think about around the middle of May, I think credit spreads had tightened basically back to where they were pre-liberation day. And I feel like our big thesis was tariffs were going to be a very prominent part of the economic strategy of this administration and investors and market prognosticators were looking through that and focusing on more of the business-friendly policies and that was a mistake. And it turns out it was only a mistake for about a month and a half if that. And so to see things, spreads tightened in so much equities rally to such a degree, that was the moment where it's like, huh, okay, well, absorbed that incredibly well. What does that mean from here? And maybe you're like, okay, well, if the market can handle that, time to get a little bit more bullish, but if you're going back to those starting valuations, that's kind of a difficult environment to get super optimistic. So I'd say around mid-May was when there was like, huh, all right, I guess we can handle that. - That's how I feel about my life regularly. Oh, I guess I can handle that, surprise. So I mean, I think that that is such kind of a good synthesis of so much of what has gone on this year. And I was thinking about the summer months when we had that July deadline around tariffs and trade negotiations and that kind of came and went with no big deal. And then at the beginning of August, we had July payrolls, which were not good. And that kind of came and went. And I was just thinking, wow, the fundamental resilience or perceived fundamental resilience is truly wild. And then thinking about just how everybody is talking about technicals and the cash on the sidelines and the cash inflows. And I don't know that these moments necessarily made me rethink my investment thesis because we have been really up to speed on so many of the technical factors and the big drivers, especially in '23 and '24. But I guess it made me really give some critical thought to how long can those technical factors last and just how much fundamental stuff they can kind of paper over in general. - Yeah, that's a great point. It seems like it's pretty substantial and more than we had anticipated coming into this year, it's kind of crazy to think that we had so many changes on so many key policy items and market performance feels in a lot of ways very similar to 2024 despite a very dynamic backdrop, I guess. So definitely a lot to digest and consider as we look ahead to 2026, but before we do that, winning if you had to describe the credit markets in just three words, the credit markets in 2025, that is what would they be and why? - So the three words that immediately come to mind are trash garbage, I mean, that's two words. Trash garbage, hot trash garbage, three words, but really they haven't been hot trash garbage. It just feels like that deeply embedded in my psyche. So I think that the true three words are pain trade tighter, like the pain trade has been spreads grinding relentlessly tighter or holding relentlessly steady, especially as I talk to so many clients about their concerns and outlook and expectations and how they're positioned. So I think 2025 pain trade tighter are the three words that I would pick. What are your three words, Zach, are they trash hot garbage? - Hot trash garbage, I like that. Mine was just a wash with liquidity and we've kind of already hit on that a little bit, but I feel like one of the stats I've pointed out a bunch in our various outlook calls and at our conference is thinking about money market funds with six, seven, eight trillion in them over the course of the past. - Six seven. - Damn it. How can I say that on a podcast? Hopefully we can edit that out. But so I mean, thinking about all of that cash and how much interest earned with rates at four or five percent, we've estimated about 300 billion in interest kicked off from these money market mutual funds per year on average since 2023. That's about the same amount you've seen in terms of inflows into investment grade mutual funds and ETF. So a wash with liquidity that seems to be what papered over any macro or fundamental concerns at least up to this point, Winnie. I had so interesting that a wash with liquidity are your three words because we've also had so many headlines this year about funding markets and liquidity stress and it just hasn't really mattered. So maybe that's the market realizing that the Fed has learned a lot of very valuable lessons related to liquidity in the system and needing to shift away from QT and actually back into kind of a QE lights, I would say, this is where we are right now. So Zach, for 2025, what is one trade or call that you got spectacularly wrong this year and what did it teach you and was it not going overweight IG in April when I told you to? - It's definitely that, but I'm gonna give myself a pass because I feel like I was on board and helped with the overweight on high yield, which was a very nice call. And unfortunately we didn't just go overweight everything with that same exact publication. Mine is going to be, and there's a lot of nuance to this. Our 10 year yield call for year end 25 was 475. Right now we're at 416. Now, I think when we put out the 2025 outlook, the 10 year yield was probably right around 4%, maybe 4.1%, that was in early December 2024. I think by year end we had hit 457. So having a more bearish view on duration was a great call for the first month that we had that view out there. And then we hit 480, just shy of 480 on January 14th. So there's another time I wish I had moved to more neutral or overweight duration. I think we managed it pretty well. I think we moved to a more neutral when the 10 year was around 463 in May, and then have since gotten a lot more constructive as we think the economy is going to slow more the labor market weakness, which we learn more about this morning with the release of October and November payrolls. So our view is basically that slowdown. You're gonna see that kind of price through the curve with a both steepening, so lower in yield and steeper in curve. I feel good about that, but I think it's interesting to think about how we try to project our views forward over 12 months. And then obviously you get a lot of new information over the course of that time, and you kind of have to adjust both your strategic and tactical views. So pour 75, that certainly ended up being high. We had no Fed cuts for this year as our base case. And so I think if anything, it almost feels like our base case for 25 is becoming people's base case for 2026 with maybe no more rate cuts and the backend rising if the Fed tries to deliver more than the market thinks is correct. But Winnie, let me turn that one back around on you since that was a very long-winded answer to a very simple question. - I don't know that necessarily a trade call that you got spectacularly wrong and your lessons learned is actually a simple and short question. But also, I think that you did a great job of navigating a lot of these things, right? Like you did not stay shackled to that 475 call. We did not stay shackled to our no cuts from the Fed. And in fact, we laid out some pretty specific parameters for labor market reports that were then hit, which caused us to revise our Fed call. And then our revised Fed call was spot on. So, you know, we got to give ourselves a little credit there for sure. - I like that, yeah, a little credit where it's due. Humility plus credit where it's due. That's what's all about. - I'm here to be your hype girl, that is for sure. So I would say that spectacularly wrong, it really does come back to navigation of all of the April liberation day volatility in the market. I feel really good that we went tactically overweight high yield. We hit some probability weighted targets on spread. And I think that the positioning within the market gave me some confidence that we could go there. I wish that we had left that on a bit longer. And I wish that we had considered broadening out that tactical overweight cross a number of other asset classes as well. And also on the EM side of things, it's been a tremendous performer this year. And I think that in retrospect, it's something that very few people saw coming. It seemed like EM was going to be front and center for a lot of the policy changes. Valuations were already not particularly exciting. But when you have just liquidity flowing everywhere, these things that are kind of higher yielding, a little bit riskier, tend to outperform quite significantly. What I'm glad about is that I had not been a massive crypto buyer heading into this year because, man, what a messy year that has been for sure. - I only wish more than that that we were large gold buyers. That was really the big trade. It was gold up 51% this year. And I feel like we had that as a question in our outlook conferences. And people then notch that as their biggest surprise as much here in the US, I think, as in Europe. So that's kind of interesting. Maybe everyone was buying gold and were the only ones that missed out on that. - I guess we just have to assume that our clients are all massive buyers of gold. So Zach, we came into the year with tariffs as maybe our number one word on our 2025 Bingo card. And we had really been talking about how the administration was going to focus on tariffs right out of the gate. How do you think that the reality of the tariff headlines and what was actually imposed met with your expectations, especially for IG corporates? - I'd say, we didn't have a very precise call, which I think based on everything we saw this year, a decision to not have a precise call was justified in that it was extremely chaotic and there were changes made seemingly daily in April in every few months since. So I think the severity of the tariffs generally met our expectations of being more intense than people everyone saying take Trump seriously not literally that phrase that became so pervasive I mean, you pretty much had to take him literally and actually more than literally what he was saying during the campaign is what we got at least in some initial announcements in terms of how it affected IG corporates or even just earnings in general, shockingly little, which is a testament to either corporates ability to navigate a very tricky policy environment from what we hear from particularly our consumer team doesn't seem like there's a lot of pricing power that companies have been able to flex and so maybe we underappreciated how much inventories could be built up and then when thinking about how that flows through earnings or how you choose to do your inventory treatment, maybe we haven't seen the effects yet. So I feel like the severity and intensity of tariffs and how central they were to economic policy in 2025 mostly met our expectations but market resilience and corporates ability to navigate those tariffs have vastly outperformed our our expectations. Did I miss anything there, Winnie? - I totally agree. I think that as I look back to 2018, which was Trump trade war 1.0 and very much focused on China, there was a lot of market volatility that year. Now, admittedly, the Fed was hiking rates and tightening policy, whereas this year of kind of the base case expectation was that the Fed was leaning more dovish, but still, the volatility in corporate credit spreads among expected economic slowdown related to US-China trade wars was quite significant and this year we had a very brief blip of volatility but even so, spreads didn't get anywhere near where they got in 2018. And that I think is really surprising. I think that that speaks to the starting point for corporate balance sheets. We had been in a kind of de-leveraging mode as the Fed had been hiking rates and corporates had been really focused on maintaining cash balances. There had already been an margin expansion phase as well with the ability to pass through pricing and so kind of the starting point for margins was really good overall. And I think that people were really focused on that rather than the kind of uncertain impact of all of the trade policy moving pieces, which I still think are a little bit less tangible than maybe I would like them to be. How much can you really quantify tariff impact? There are some sectors and some issuers that are being very candid around it, but a lot are not as much and still a lot of open questions. So I think that the default has been to think, okay, well, things have been okay and then they will continue to be okay overall. - I feel like that's the big thing that is also different this time around when we were thinking about the tariff impact, the idea was we get an announcement and the market's gonna react strongly before we see it in the economic data or the earnings data and I feel like that historically has been how the market has approached attempting to price in bad news. You're gonna have it priced in to financial markets before you see it in the real economy. And now it seems like everyone's willing to stay at the party until the last drop of punch has been consumed and feels like no one knows when that is, but there's a greater willingness to stick around now than let's say pre-COVID. And maybe that's just the result of, I feel like I come back to this every so often, the $8 trillion combination of monetary and fiscal stimulus in the early 2020s and just how long that's taken to work its way through the system or how much staying power it's had, given how powerful it was that combination. So I think that's another kind of big surprise that is a paradigm shift. And I mean, I think emerging markets is to think about, to me, the stereotypical most at risk in a big up-tick in Terraforzaean would be EM and it's vastly outperformed. And so I feel like a lot of these historical norms have really been turned on their head this year. - Yeah, absolutely. What's $8 trillion between friends? Definitely something that will keep the party going for sure. So on that note, we had a really interesting monetary policy landscape this year where in 2024, in Q4 and beginning late Q3, the Fed started easing policy and then kind of sat on hold for a while and then started easing again. So was that 2024 pivot actually a pivot or was it just kind of proactively adjusting policy and now we're doing a little bit more of that now? How did monetary policy surprises kind of reshape your viewzac of both duration within the rates market and the outlook for credit spreads? - Yeah, it seems like it's been sort of at this point two proactive adjustments at the end of 24 and 25, which we can kind of say that now it remains to be seen what happens in 2026. But if that ends up being the case, I think you can say it was for 2024 and that ended up being great for markets in 2025, could happen again. I do think considering monetary policy expectations and the impact on markets over the past couple of years has been we're expecting cuts and therefore that's kind of just an insurance policy on the market. Everyone's pretty comfortable with that idea and that takes some of the most extreme tail risk out of people's minds and has kind of fostered a more robust financial market backdrop. I think our big call for 2026 is the Fed goes from being able to proactively do a few rate cuts here and there to reactively cutting in a way that they need to get back to at the very least clearly neutral and maybe into at least modestly accommodative territory as the labor market weakens further. And so given our call for the labor market to weaken further to really reveal what has been a more vulnerable consumer underneath what some of the macro data suggest to us, I think that's the big shift in terms of monetary policy. So Winnie, I want to turn it to you. I don't know if that's a super contrarian view. I think it is pretty contrarian right now but what is your spiciest contrarian take? What is the market getting completely wrong heading into 2026? So I think that my spiciest contrarian take is on the new issue supply side of things. Our new issue forecasts are meaningfully lower than consensus estimates for investment grade, high yield, broadly syndicated loans, and I think that the market is getting that wrong. Now a lot of this is predicated on our spread call. We expect wider spreads and more spread volatility, which is kind of a natural killer of new issue supply. And I totally understand the impulse to take new issue forecasts up, right? Like we've had a lot of M&A announcements, the AI infrastructure and spending announcements have been massive, the CAPEX plans are quite massive. But I think that if you are going into the year, expecting that it's just going to be kind of a repeat of 2025 and 2024 from a fundamental perspective and that there's just not gonna be any spread volatility, that makes me a little bit nervous. I think also the high yield versus broadly syndicated loans versus private credit interplay, there is now this perception that there's going to be more funding going to high yield because there's going to be just kind of more flows there. But I think that if we have our Fed call rights, then borrowing costs are actually gonna be falling more in the broadly syndicated loan market than in the high yield market. And so that combined with all of the other things that the SL gives you over high yield, like covenant flexibility and payability and ability to kind of push some of the leverage metrics, that's me indicates that BSL new issue might be outpacing what we see in the high yield market. - All right, I think that's an interesting one that probably doesn't come up enough in some of our discussions. And one more I wanna hit you with is if you could only invest in one sector for the next 12 months, what would it be and why? This is a fun one. There hasn't been a preview discussion of this. So this is gonna be a real time answer for me as well. - All right, one sector for the next 12 months, I think that I'm gonna have to go with Davis A Bears call on high yield media. It has some yield, it has some positive event risk. We get the midterms with some ad spend, consolidation is gonna be the name of the game. And so if it sets up like Telecom has this year, that's a nice double digit total return prospect. So that's what I'm gonna go with and shout out to Davis for really nailing the high yield Teleco call this year. So Zach, what's yours? What's your sector that you are top pick? - I'm gonna flip it around and say top pan. So the sector I would want to invest in leases, investment grade tech with 600 billion of hyperscaler catbacks coming. You're already seeing it priced into Oracle. That's certainly a very prominent now. That's really, I mean tech spreads have widened a lot, especially relative to their historical relationship to the overall index. We think that that's gonna widen a lot more. And I think in this softer economic environment, Fed may be reactively cutting. There's gonna be a little bit less tolerance or willingness to just price in the best case scenario and think that all of these investments are gonna return something meaningful. So I think I'll switch it around a bit and say avoid investment grade tech is my key call. - Yeah, I think that that makes a ton of sense. And I personally will be very curious about the ratings trajectory of Oracle over the next 12 to 24 months. We don't have a big fall in angel call on that, but I think it might end up being a little bit of a nail-biter for sure. And I guess that's a nice segue to the age-old discussion with in credit portfolios of macro versus micro. So Zach, this makes sense 'cause you are ahead of macro strategy. What matters more do you think for performance next year? Is it the big picture economic monetary policy story or are we thinking bottoms-up fundamentals are going to really drive portfolio performance? - This is kind of lame, but I think I'm gonna go with both. They're obviously interconnected. If you have a slower macro backdrop, that's not great for fundamentals. But I think the bigger bottom-up fundamentals is going to be the re-leveraging with hyper-scaler cap acts, M&A, other late cycle type, intentional re-leveraging behavior. I think both of those things, on the macro side, the consumer and labor market driven slowdown, and maybe some of this late cycle behavior in US corporates, I think that both of those hit the market in a way that kind of causes this repricing of credit risk back toward the middle of the long-term historical range, 20. This is like when my kids ask me, which one is my favorite? And I'm like, oh, I love you both, just in different ways. That's the macro versus micro debate for you, Zach. So I'm gonna take the micro. I think the micro is really gonna matter. It's of course going to be influenced by the macro, but as we've seen, broad-based ratings, momentum that's been very positive, and now we've shifted to a focus on, what kind of re-leveraging can we do? What kind of event risk do we have? I think that that is going to be a major driver in credit portfolios. And perhaps I'm talking my own book because I work for a credit research shop that does single-name recommendations and shout out to the broader analyst team because they have absolutely nailed so many great calls for the past few years. So I'm going to focus on the micro and try to marry that into some of the macro themes for 2026. So Zach, as we wrap up our last conversation of the year, I would love to hear from you. What's a question you wish more investors were asking right now, but nobody is. Sometimes we actually get asked this question on client calls and I oftentimes have a hard time thinking of one. So what you got from me, Zach? One question that we have not gotten asked in a long time is what could go wrong, right? I feel like when I joined credit sites, it was all about where are the risks? What are we not seeing? No one's asking those kind of questions right now. And I don't know that I wish they were because it makes me feel more comfortable with our more cautious outlook that people don't seem to have their eye on the ball as much in terms of risks and are more focused on maybe how long it can stay fully invested. But that's one, I feel like assessment of risks was so much more prominent, I'd say in late 2022 than it is today. Do you have the same experience, Winnie? I mean, I know we do a lot of calls together, but we do a lot of our own calls and meetings separately as well. Yeah, I think that's a really great point because people are not asking broadly what could go wrong. People have identified like a handful of their hot button topics, right? Like what about hyper-scaler cat-backs and new issue? What about private credit? But there's not this broader kind of assessment of what are the like true weak spots? What are we not considering? And I agree, like I think that that is something that we should be thinking about more and in fact on our risks for 2026, we included some kind of out there things. We have a potential kind of breakdown in the broader like system from all of the infrastructure and outages like in this new cloud-based world, we've seen some interesting things happen and at what point do those things actually become a little bit more systemic or moving the needle and that could be kind of a scary situation overall. So I really like that question of like what could go wrong and trying to take a step back and not just think about how private credit is going to blow up the entire financial system or how meta-spending is going to be something that pressures IG spreads wider and thinking a little bit more comprehensively overall. All right, so here's our lightning round. We're ready for the stack. - I'm ready, let's do it. - Okay, so we're gonna do a little lightning round and we are going to do one word answer of bullish or bearish on a few different topics. So Zach, the first one is are you bullish or bearish on private credit eating public market share? - I'm bullish as we think it's going to be a little bit of a softer year for the public markets. - Yeah, I would agree with that for sure. The private markets are still very well capitalized. Bullish or bearish on covenant quality. - Bearish big time. - Yeah, double super secret bearish covenant quality for sure. How about bullish or bearish on refinancing risk? - I'm bearish, I think that's another one that maybe we didn't say explicitly for the IG market, but I think we've got about a trillion per year and maturities for the next few years. That could get uncomfortable pretty quickly if we do see spreads widen as much as we were calling for. - Yeah, I would say that I am more bearish on IG refirisk than lovefin refirisk in the next couple of years. We really need to get to 2028 to see lovefin maturities be at all noticeable. - All right, I think I know your answer for this. Bullish or bearish on AI capex impact on credit. - Super bearish. - Super, super bearish on that for sure. We're already seeing that. All right, last one, Zach. Bullish or bearish on another year of credit site strategy in 2026. - Super bullish. I just hope it's a little easier than this past year. - You know what, here's the thing though. In volatility comes opportunity. So I hope it's easier from a, we actually get some vol perspective and not just a whole lot of headlines and a nothing burger of market action to follow. - Yeah, as a whole lot of headlines and not much vol, the worst case scenario. - Absolutely, I mean, it gives us something to talk about, but not a lot to do overall, which is wildly frustrating. I know for us and probably many of our clients who have been trying to figure out how to put capital to work in a thoughtful way that is really going to respond to all of these headlines. It's been super difficult. All right, with that, we're gonna close out our final credit sites no more risk better podcast episode of 2025. Thank you all for listening this year. If you have follow up questions, you can always reach out to me and Zach or to your credit sites sales representative. I hope everyone has a very happy holiday season and best of luck in 2026. Thank you, Zach. - Thanks, happy new year, everyone. - Credit sites, Claymore. 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