Corporate Credit Outlook 2024: High Tide for Yield?

January 12, 2024

4 min read

Will Smith, CFA| Director—US High Yield

Robert Hopper| Director—Corporate Credit and Economic Research

Tiffanie Wong, CFA| Director—Fixed Income Responsible Investing Portfolio Management; Director—Global & US Investment-Grade Credit

Weakening economic fundamentals shouldn’t scare away corporate bond investors in 2024—provided they keep a close eye on credit quality.

Investors tend to worry about corporate bonds late in the credit cycle. That’s because prolonged monetary tightening and high interest rates eventually curb growth, increase costs and raise the risk of default. But this time, things look more encouraging. Here’s why.

Fundamentals Have Weakened but Remain Solid

Fundamental metrics are showing signs of deterioration to start the year, particularly among the lowest-rated credits. Revenue and earnings growth, EBITDA margins, and interest coverage ratios are all coming under pressure (Display).

Corporate Fundamentals Under Pressure

Line charts showing net leverage, interest coverage and EBITDA margins have weakened but are still strong.

Historical and current analyses do not guarantee future results.
EBITDA: earnings before interest, taxes, depreciation and amortization
Metrics data are calculated using median.
Through September 30, 2023
Source: J.P. Morgan and AllianceBernstein (AB)

Fortunately, these same metrics are coming off historic highs, thanks to a pandemic-fueled default wave that vanquished weaker players and prompted survivors to be more fiscally prudent. In fact, revenue growth and EBITDA margins aren’t far removed from their highest levels in more than a decade. And interest coverage ratios are strong enough to stay above average in both investment grade and high yield, even if issuers refinance at today’s elevated rates or earnings decline.

A deeper dive into fundamentals uncovers opportunities, too: among nonfinancial firms, EBITDA margins for BBB-rated securities are similar to those of A-rated issues, offering investors in BBBs a similar earnings profile at higher yields.

Sound balance sheets mean corporate issuers can withstand increased pressure as growth and demand slow. This is reflected in corporate credit ratings, which have improved across the entire investment-grade universe, with upgrades outpacing downgrades by a wide margin (Display).

Credit Rating Upgrades Have Largely Outpaced Downgrades

US Credit Rating Migration (USD Billions)

Bar charts showing credit upgrades have outpaced downgrades in all but one quarter since Q4 2022.

Historical and current analyses do not guarantee future results.
IG: investment grade
As of December 31, 2023
Source: J.P. Morgan, Morgan Stanley and AB

Further, companies have alleviated financial pressure by extending their maturity runways. Only 10% of the high-yield market will mature by the end of 2025, and most of this debt will be of higher quality. Gradual and extended maturities slow the impact of higher yields on companies, while higher-quality issuers should have little trouble refinancing (Display).

Little Debt Set to Mature Before 2026

High-Yield Maturity Schedule

Bar charts showing that most high-yield debt will mature after 2026, with the bulk of this comprising higher-rated debt.

Current analysis does not guarantee future results.
As of September 30, 2023
Source: Barclays and AB

As a result, we expect a moderate default rate for the next 12 to 18 months—around 4% to 5%—rather than a tsunami of defaults and downgrades. That said, we think investors should favor higher-quality credits, remain selective and pay attention to liquidity. CCC-rated debt—particularly credits in cyclical industries—are most vulnerable to defaults and economic downdrafts. Debt rated B or higher may be a better choice in today’s environment.

Yields and Spreads Remain Elevated

Yields enter the new year still elevated by historical measures (Display).

Even After a Late 2023 Rally, Yields Remain Compelling

Line charts showing investment-grade bond yields elevated in the US, Europe and the UK.

Historical and current analyses do not guarantee future results.
IG: investment grade
Each index yield to worst shown in the respective local currency
Through December 31, 2023
Source: Bloomberg and AB

How long they’ll remain at these lofty levels depends on how successful central banks are at warding off inflation. Owing in part to lower economic growth rates across the eurozone, the European Central Bank can cut rates earlier than its peers, while disinflation may have further to run before the Bank of England eases monetary policy. The US Federal Reserve has signaled its intention to cut rates three times in 2024, but for the time being, the fed funds rate is at its highest level in more than two decades.

High-yield investors are among the best positioned to benefit from today’s elevated yields. A high-yield bond’s starting yield to worst has historically been a strong predictor of return over the next three to five years. Today, the yield to worst for the global high-yield market is 7.6%.

Within investment grade, European credit spreads—the difference between corporate bond yields and government bond yields—narrowed by more than 50 basis points (bps) over the past year but are still 25 bps above their historical norms. US investment-grade credit spreads currently hover near their long-term averages. Given large flows into money market funds in recent years, when investors become more comfortable with more interest rate–sensitive duration securities, we would expect demand for investment-grade credit to increase substantially.

Intermediate-Term Credits Offer Value

But averages can be deceptive. A closer look reveals that intermediate-term corporates are a much more compelling opportunity than long-term ones. Why? Yield-focused investors such as insurance companies have been buying long-dated investment-grade securities to match their long-dated liabilities, driving long yields down relative to the rest of the market. As a result, we believe longer-term bonds don’t compensate investors for the added term risk.

This phenomenon is global: US, UK and eurozone bonds longer than 10 years all look expensive relative to intermediate-term credit. For this reason, we believe that some of the best value can be found in the belly of the yield curve within investment grade.

Lastly, technical conditions have also improved since the pandemic, aided in part by increased demand, positive ratings changes and limited issuance. In the US, investment-grade bonds saw monthly inflows through the third quarter, underscoring investor confidence, which in our view should help support valuations in 2024. In Europe, technical factors have been more mixed.

Given the uncertain economic outlook in 2024 and fraying fundamentals, investors could be excused for eyeing the corporate credit markets with caution. But today’s high yields won’t last forever, and with valuations still reasonable, the start of the new year could present a unique opportunity for prudent fixed-income investors.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Authors

Will Smith, CFA

Will Smith is a Senior Vice President and Director of US High Yield Credit. He is also a member of the High Income, Global High Yield, Limited Duration High Income, Short Duration High Yield and European High Yield portfolio-management teams. Smith designed and is one of the lead portfolio managers for AB’s Multi-Sector Credit Strategy, which invests across investment-grade and high-yield credit sectors globally. He leads the monthly High Yield portfolio-construction meeting, and is a member of the Credit Research Review Committee, which determines investment policy for the firm’s credit-related portfolios. Smith has authored several papers and blogs on high-yield investing, including one on the importance of using a probability-based framework to build better portfolios. He joined AB in 2012, and spent 2014 in London as part of the European High Yield portfolio-management team. Smith started his career with UBS Investment Bank, working as an analyst with the Credit Risk team and then later on the Fixed Income sales and trading desk. He holds a BA in economics from Boston College and is a CFA charterholder. Location: Nashville

Robert Hopper

Robert Hopper is a Senior Vice President and the Director of Corporate Credit and Economic Research. He joined AB in 2013 and now oversees the teams that provide fundamental analysis of global investment-grade, high-yield and emerging-market corporate and sovereign issuers and global economic analysis. Hopper is also responsible for driving the corporate credit research outlook for the Fixed-Income department. He sits on various internal investment committees and is the author of a number of published papers, focused on insights into corporate defaults and fallen angels during the COVID-19 pandemic, inflation risks, and rising star candidates. Earlier in his tenure at AB, Hopper was responsible for coverage of the high-yield telecom, cable, satellite and media sectors. Prior to AB, he was a managing director and head of the High-Yield and Investment-Grade Credit Analyst team at UBS Investment Bank, where he was also the senior high-yield and investment-grade telecom, media and technology analyst. Earlier in his career, Hopper served as an equity analyst at UBS and Bear Stearns. He holds a BS in accounting from Saint Michael's College and an MBA from Boston College. Location: New York

Tiffanie Wong, CFA

Tiffanie Wong is a Senior Vice President and Director of Fixed Income Responsible Investing Portfolio Management. In this role, she is part of the leadership team that develops responsible investment strategy across AB's Fixed Income business, particularly related to integrating environmental, social and governance considerations throughout the team's portfolio construction processes and overseeing management of several of the team's sustainable strategies. Wong also serves as Director of Global & US Investment-Grade Credit, responsible for the management and strategy implementation of the firm's Global & US Investment-Grade Credit portfolios, including total-return and income-oriented credit strategies for institutional and retail clients. She has worked closely with AB's Quantitative Research team to leverage the firm's technology innovations within fixed-income trading and research to apply a more systematic approach to AB's credit investing. Prior to joining AB's Fixed Income portfolio-management team, Wong served as an associate portfolio manager on the Credit team, focusing on various strategies for the Global and US Credit portfolios—including total return, buy and hold, and liability matching. Before joining AB in 2012, she was a fixed-income portfolio analyst and trader at Segall Bryant & Hamill and a fixed-income portfolio associate at Wells Capital Management. Wong holds a BA in economics with a minor in business institutions from Northwestern University and is a CFA charterholder. Location: New York