Worries about the death of the U.S. credit cycle have been persistent this decade, and have recently ratcheted higher. We have argued for several years that corporate finances are less vulnerable than the consensus believed, and the corporate sector would likely be a casualty of an economic downturn, not the cause.
This remains our view, although we acknowledge that spread narrowing is quite extended on a cyclical basis. Corporate leverage has indeed increased significantly and risks are mounting. However, overall debt servicing capability remains solid, even though there are areas of deterioration in the lowest quality segments of the sub-investment grade market.
In the end, however, a broad-based blow-up in credit will only develop once the economic cycle ends and a sustained profit contraction takes hold. We do not foresee such an outcome in the next 6-12 months, and continue to recommend an overweight stance on U.S. corporate credit within a fixed-income portfolio.