Key Takeaways
- Investment Grade valuations remain tight, and the market remains focused on whether this is justified by fundamentals. Our bottom-up company analysis shows profitability remains strong and leverage modest
- We examine emerging trends as we move into 2025 and highlight sectors which will be most impacted
- Geographically, we believe issuers in the US indices are in a better position than their European-based counterparts going forward
Investment grade (IG) indices remain close to recent tights. Similarly, corporate fundamentals are in an extremely strong position. Our credit work looks to identify where there is a mismatch between the fundamental expectations and valuations of issuers, on a name-by-name basis. We also aggregate the single name expectations each quarter to give a view of the market as a whole. This is based on the detailed, bottom-up forecasting our analysts complete on each of the names they cover and gives a perspective on the health of the largest corporates in the US and Europe, highlighting both winners and losers.
Figure 1 Spread (OAS) history and long run average
Source: ICE indices, as at 27 September 2024
At this point in the year, we can have increasing confidence over how 2024 will turn out and the focus starts to turn to the outlook for 2025. While it is still too early to take a lead from management teams’ official guidance, certain themes are starting to stand out as potential threats and opportunities, which we highlight below.
Overall, from a credit perspective, fundamentals are in a very strong place. Post-Covid-19, the business environment has been very supportive to credit strength, with cost and efficiency measures put in place during the pandemic flowing through to profitability and cash flow.
We are starting to see some differences in the aggregate numbers between US and European-based corporates. Our forecasts for the US show moderate improvements in ’25 for both margins and leverage (the amount of debt a company has relative to earnings – the lower the better), whereas in Europe we see a slight deterioration (Figures 2 and 3).
Figure 2: EBITDA margins, US (top) and Europe (bottom)
Source: Columbia Threadneedle Investments’ analysis, as at September 2024
Figure 3: debt and leverage levels, US (top) and Europe (bottom)
Source: Columbia Threadneedle Investments’ analysis, as at September 2024
The constituents of the data sets are very different, so these aggregate numbers should be viewed in the context of the sector outlooks below. Common between the two, however, is that balance sheets remain in a good position from a historical perspective. Margins are strong and leverage remains lower than pre-Covid levels, which is supportive for credit spreads.
Going forward
As we look ahead to 2025 there are some themes to note:
The hype around artificial intelligence is real. No matter what your views are on the ultimate applications, the cash being spent on infrastructure and development is significant and growing. We expect this to continue into 2025 and beyond. This will have a huge impact on the technology and telecom sectors globally, both of which are well placed to benefit from these changes.
In industrials, building materials earnings continue to rise, with margins supported by strong pricing and product mix, no Chinese exposure and a strong US market. Capital goods margins also remain high, with demand from secular trends supporting segments like smart infrastructure largely offsetting weakness in robotics and factory automation. We expect these trends to continue.
The bottleneck in the healthcare system caused by Covid-19 continues to be cleared. Utilisation of medical services remains at an elevated level, which is good for providers and equipment makers but puts pressure on insurance providers. The latter will be pricing 2025 policies with the continuation of these higher utilisation rates in mind, potentially lowering benefits for consumers but improving profitability.
The health of the consumer will remain very much in focus. There is already evidence that the lower end consumer is feeling the economic pressure, while at the other end of the scale some luxury goods names have seen negative revisions due to poor performance in China. At a corporate level, we expect this will lead to a return to the pre-Covid-19 low growth environment for consumer goods names. Companies are, however, in a good financial position to be able to supplement that anaemic growth with acquisitions. We expect more deals in the space in 2025.
Boeing is a large enough name that any changes it makes have an impact on aggregate statistics. We continue to expect the company to recover from its safety issues and the impact of Covid-19, but the timing remains uncertain.1
The biggest change on a sector level has been in autos, which is a larger part of the European numbers and explains much of the difference between the US and European data sets. Here, we have seen downward revisions to expectations for both volumes and margins, with profit warnings coming thick and fast and considerable uncertainty remaining. The impact has been seen most in the Chinese market where softer demand and strong competition has caused pressure on profitability. Auto profitability is highly sensitive to volumes. The growth in battery EV demand has also moderated from higher historic rates and an area to watch closely.2
Conclusion
Given the tight valuations, the market remains hyper focused on any suggestion that corporate fundamentals are not in a place to justify them. Our work would suggest that, overall, the health of the average IG issuer still very much does support a premium valuation. However, if you were to look very closely for the first signs of cracks, autos and the lower end consumer would bear close attention in the coming months. Geographically, we believe US names are in a better position than their European counterparts.
