Global Weekly Commentary: Public or private? A strategic question
Public vs. private
We prefer private to public credit long term on better return potential. It’s the mirror image in equity: We prefer public stocks as risks fade in the medium term.
U.S. stocks hit 2023 highs on hopes for a debt ceiling deal. Yields climbed on odds of another rate hike versus a pause or cuts. We don’t see rate cuts this year.
U.S. PCE this week will help gauge inflation’s persistence. We see wage pressure from worker shortages keeping inflation above policy targets for some time.
The banking tumult has reshaped opportunities for income: We now favor private over public credit on a strategic horizon of five years and longer. We think private credit could help fill a void left by banks pulling back on some lending and offer potentially attractive yields to investors. We see a mirror image in equity, strategically preferring public to private: Public stocks have repriced more than markets like private equity, and we see risks fading over a medium-term horizon.
Credit bond yields, 2016-2023
Source: BlackRock Investment Institute, with data from Lincoln International and Barclays Live, May 2023. Notes: The chart shows yields for direct lending, U.S. high yield debt, U.S. investment grade credit. The indexes used are: Lincoln Senior Debt (based on valuation data from 2017–2022), Bloomberg U.S. Corporate High Yield 2% Issuer Capped Index and Bloomberg U.S. Credit Index. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index.
Investing in private markets takes time. So we see the repricing in private credit as an opportunity to be nimble with our strategic views and tap into our expectation that private credit can help fill a lending gap left by banks after the recent turmoil. Yields in direct lending, a subset of private credit, have risen (dark orange line in chart). These higher yields may better compensate investors for the risks we see ahead – even after factoring in lower credit quality. U.S. high yield and investment grade (IG) credit yields have faded from highs (yellow and pink lines), but we think they will rise eventually. We go overweight private credit as a result and move to neutral on global IG. Private markets overall are complex, with high risk and volatility, and aren’t suitable for all investors.
The fallout from the banking sector troubles and further tightening of credit conditions adds to the pressure on public credit but could be a potential boon for private credit, in our view. We think the rising interest rate environment and increased competition for deposits will put pressure on banks – and cause them to pull back some lending. We see this making room for non-bank lending and private credit to play a greater role.
Private credit appeal
Private credit refers to a wide range of investments, from direct lending to infrastructure and venture debt. We’re focused on direct lending – financing that is typically negotiated directly between a non-bank lender and a borrower, often a small to mid-sized company. This private credit is mostly made up of floating rate debt that adjusts with policy rates that we see staying high. We think there are potential benefits from a borrower’s perspective in seeking out non-bank lending. Dealing with one private lender could be easier than a broad group of banks as in public markets. The private nature could also help avoid spooking financial markets, such as with the risks that come with tapping funds from public markets at inopportune times. This demand from borrowers creates an investment opportunity for lenders, in our view: more attractive pricing and deal terms than would have been the case before.
But we think seeking out quality borrowers is key: That means a keen eye on deal terms and lending standards. We have had a conservative view on our assumptions about private credit default losses in our strategic views for some time because private credit is not immune to the credit risk from an economic downturn. Yet even after allowing for these more prudent assumptions that would be a drag on returns, the wider set of opportunities for private lenders in the wake of the banking fallout, coupled with the divergence between private and public credit yields is enough to spur an upgrade.
Our strategic view on equities is the mirror image of credit: We prefer public to private. We’re still strategically overweight developed market (DM) equities but underweight on a six- to 12-month tactical horizon because a strategic investor can look past some of the near-term pain. And the pressure from tighter credit conditions is also likely to have relented down the road. We remain strategically underweight growth private markets such as private equity. Private equity has started to reprice the tougher macro environment but not as much as publicly traded equities.
Our bottom line
We see the appeal of income in the new regime of greater macro and market volatility and favor private over public credit on a strategic horizon. We see a mirror image in equity, strategically preferring public to private.
U.S. stocks hit 2023 highs last week on hopes for a debt ceiling solution. Yields climbed on expectations the Federal Reserve could hike rates again instead of pausing at its next meeting. First-quarter earnings contracted for the second-straight quarter – but less than expected. Inflation helped revenue and margins as firms passed on higher prices to a still-strong consumer. We think higher financing costs and dwindling savings could start to bite: Earnings expectations look too rosy.
We’re watching U.S. PCE closely this week, the preferred inflation gauge of the Federal Reserve. We expect inflation to remain above 2% policy targets for some time – that’s why we don’t see the Fed cutting rates this year. Global PMIs will help us gauge how much interest rate hikes are hitting economic activity in developed markets.
Euro area consumer confidence
Global flash PMIs
U.S. PCE inflation
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of May 18, 2023. Notes: The two ends of the bars show the lowest and highest returns at any point in the last 12-months, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.
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