American Funds video transcript: “Credit risk in today’s fixed income environment” 

Will McKenna: It seems like most eyes are on the Fed and rising rates. But also credit risk, as it turns out, may be the more important issue in 2019. I've heard you and the team talk about this. Tell us more. What do you see as the issues there, and how should investors be thinking about credit risk?

John Smet: I think a lot of companies followed the quantitative easing playbook. And if you think about interest rates going down, it encouraged people to reach out and grab for yield. So, companies could buy another company and issue a lot of debt — investment-grade debt or, in some cases, high-yield debt. Investors bought that at a very tight spread, and that was very attractive for the companies.

So, you have a lot of companies right now that issued a lot of debt, well-received by the marketplace. And now, they're looking at, “I've got $40 billion of extra debt,” “I've got $100 billion of extra debt — I'd like to de-lever my balance sheet.” Well, if you are going to go from a slower growing economy, and perhaps more volatility in spreads, it may be tough for those companies to do that, because they all want to de-lever, but we're a slow-growing, mature economy. And you have to refinance some of this debt every year. If you’ve got $100 billion in debt, you’ve got to come to market every year. And so, the market may not be that accepting.

So, I think we worry about that: large companies that may be downgraded with large debt from single-A to triple-B. And some companies may go from triple-B to on the edge of high yield. So, that transition we're seeing — there's a lot of debt and a lot of re-leveraging of corporate America. So, we worry about that.

And right now, we're not being paid that much. In the last few weeks, we're getting more yield premium, but really, we're not getting paid that much for the risk that we see in 2019, with more volatility, maybe higher bond spreads and big companies trying to de-lever. So, I think that the credit market — the investment-grade credit market — we see a lot of dangers there, and we just don't think we're getting paid for it right now.

Will McKenna: So, the idea is to upgrade and stay very high quality in that part of the world?

John Smet: Stay very high quality — and even owning Treasuries. Treasuries are probably our favorite investment right now.

 

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