Opportunities for Insurers Within a Shifting Credit Cycle
September 21, 2022
By Matthew Daly, CFA, Managing Director and Head of Corporate and Municipal Teams
Monetary policy around the world is changing as many central banks are attempting to tighten financial conditions in order to control rampant inflation. As illustrated in Figure 1, negative-yielding sovereign debt has seen a nearly 10-fold decline across the globe.
The tightening has generated recession fears and market volatility and contributed to wider corporate spreads. There are concerns that the Fed, in an effort to squelch inflation, will ultimately destroy demand and trigger a recession. Indeed, with two consecutive quarters of GDP contraction in 2022, it appears the economy has, at a minimum, slowed meaningfully. While corporate fundamentals are currently on solid ground, investors are weighing the impact of a possible recession on the corporate market.
Despite the macro uncertainty, Conning believes opportunities can be uncovered by applying strong analytical skills and investment discipline as well as by leveraging our deep experience in managing through market cycles. While the months ahead should feature higher volatility, they should also present distinctive opportunities as yields are at some of the highest levels in a decade.
We see potential in issuers with durable credit fundamentals that can weather an economic downturn while keeping their credit profiles largely intact. Additionally, securities that were issued recently when interest rates were lower and credit spreads tighter are now available at a meaningful discount to par. Many may be opportunities for longer-term investors - such as insurers - who can hold them to maturity.
Fundamentals: Holding Up but Pressure Mounting
The slowing economy and rising concerns of recession contribute to Conning’s belief that the corporate market is moving into the later stages of the credit cycle (see Figure 2).
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Market Risk - Market, or systematic, risk is the risk that individual securities may be correlated with general market downturns regardless of the particular business conditions and outlook for the individual companies.
Credit Risk – eroding fiscal health in issuing companies resulting in inability to meet debt obligations.
Inflation Risk - Inflation erodes the purchasing power of future cash flows from investments. In times of high inflation the value of securities may be reduced.
Liquidity Risk - Liquidity risk can occur when market conditions do not allow transactions to be made in a quick and orderly fashion in relation to indicative market prices.
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