According to Turning Rock Partners, stocks and bonds rallied hard last week after seeing April’s inflation data as somewhat positive news that support possible rate cuts later this year.
The latest U.S. jobs results were fairly benign with respect to average hourly earnings and tempering of monthly payroll gains. Price increases seen in the U.S. services sector may be stickier than previously thought. Residential rent growth, for example, remains challenging to contain with monthly price increases running at 40 – 45 bps per month. Within equities, the S&P 500 hit its 23rd record high close of the year. While most of this was driven by the ‘Mag 7,’ equity markets are gaining momentum. Markets are anticipating an impending Fed pivot but an elegant soft landing from restrictive interest rate policy may prove more difficult than expected.
Credit conditions aren’t likely to brighten in the near term. Elevated financing costs and input price pressures drive persistent risks. Default rates within high yield and leveraged loans remain lower than expected despite higher coupon pressures. Par-weighted U.S. high yield and loan defaults ended April at 2.3% and 2.9%, down from the 25-year averages of 3.4% and 3.0%, respectively. While it seems certain corporates can manage through higher interest rate cycles with tighter cash management, risks of a more distressed environment is clear and present.
Year to date in 2024, 18 companies have defaulted on $12.5 billion worth of corporate bonds and loans while 11 companies have completed a distressed exchange totaling $12.8 billion. Looking at distressed deal volumes year to date, the market is tracking ahead of 2008’s record high of $35.2 billion. In addition, approximately 30% of issuers have received negative or on credit watch ratings. This is just in the corporate credit market.
Impending U.S. commercial real estate distress looms large. Distressed volume combined for office, retail and hotels stood at over $85 billion at the end of 2023 and is picking up. Foreclosures are picking up as occupancy across many areas remain weak. Lower occupancy, overleveraged capital structures and untenable carry costs are forcing many lenders to foreclose on properties. March 2024 alone saw over 625 foreclosures, up 117% year over year.
Elections are coming down the pike. A global election cycle is also heating up, with 60 of 77 elections pending including the UK, Mexico, India and many more. The 2024 U.S. election, for which most voters are dreading, is just around the corner. U.S. corporates are anticipating major uncertainty depending on election outcomes tied to shifts in fiscal/tax policies, foreign relations and stance on trade. The current candidates have polarized views which adds further complexity to asset owners who are budgeting for future capital spending, shareholder activity and tax planning. Looking to the back half of 2024, Turning Rock Partners predicts the rate-hike induced M&A slump may ease towards the end of the year once elections over.
