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The financial terrain is undergoing substantial changes as we navigate through volatile markets and altering economic circumstances. With heightened volatility reminiscent of the financial crises of the past, investors are re-evaluating traditional portfolio strategies and exploring new opportunities to mitigate risks and capitalise on potential returns. In this blog, we will explore the current market conditions, the benefits of fixed income over equity, the stabilising role of private credit, and how global and Asian markets are adapting to these changes.
During the early August stock market decline, the VIX (Volatility Index), a significant measure of the stock market's expectation of volatility based on S&P 500 index options, rose to its third-highest level 65.73 since the financial crisis in late 2008 when it closed at a record 80.74, and the highest spike was 85.47 caused by COVID-19. This environment underscores the need for discipline in portfolio management strategies.
The recent market turmoil is a result of worries surrounding the U.S. economy's ability to smoothly transition, increasing rates of unemployment, and the unravelling of the yen carry trade. In July, there was a notable slowdown in job growth in the U.S, with the number of new jobs created dropping from an average of 200,000 over the past year to just 114,000. This decline can be attributed to the impact of the Federal Reserve's recent rate hikes. The unemployment rate also ticked up to 4.3% in July, from 4.1% in June 2024.
The yen carry trade has been unwinding as Japan raises interest rates, leading to sell-offs in U.S. fixed-income assets, tech stocks, and other investments. This trend has amplified losses across major markets. If the U.S. economy manages a soft landing, it could lead to a reduction in the federal funds rate, benefiting government debt and private investments. However, factors such as deglobalization, energy transition, military spending, and immigration restrictions could sustain inflationary pressures over the next 3-5 years.
With traditional banks reducing their role in extending credit, private credit is gaining prominence. As a result, the traditional 60/40 portfolio is being re-evaluated, with more emphasis on private equity and private credit to enhance returns and reduce volatility.
Assigning a portion of your investment portfolio to fixed income can act as a safeguard against market instability because fixed income instruments often have a low or negative correlation with other types of assets. Fixed income instruments are designed to deliver a consistent stream of income payments. While stocks can offer dividends, these are not guaranteed and depend on the company's discretion. In contrast, high-quality fixed income instruments typically offer a reliable source of investment income, even in volatile environments.
The chart shows the S&P 500 10-Year Price/Earnings (P/E) Ratio, also known as the CAPE (Cyclically Adjusted Price-to-Earnings) Ratio, as of June 30, 2024, with a value of 35.0 is significantly above its historical average, indicating that the S&P 500 is relatively overvalued compared to historical norms. While we are not predictors of equity markets for the future, what is certain is that the equity markets are overpriced on a long term basis - which warrants some attention or rotation to fixed income.
Private debt has emerged as an attractive alternative source of credit, representing a stable and predictable income stream in an environment where volatility can impact returns. It serves as a diversification tool away from public markets and is considered a resilient asset class.
The Private Debt index demonstrates a steady and consistent upward trend, with minor fluctuations. This reflects the asset class's ability to provide stable returns over the long term. Similar to the broader market, there was a dip during the 2008 financial crisis, with the index briefly dropping below 100. However, the recovery began swiftly and has continued since. The graph underscores the attractiveness of Private Debt for investors seeking stable, long-term growth with lower volatility compared to more traditional equity investments.
When compared to various asset classes, both private and public, private credit emerges as a particularly stable option. The IMF's April 2024 report underscores this stability, highlighting that private credit experiences lower volatility, with market disruptions having a more subdued impact on its compounded returns. Between December 2000 and June 2023, private credit not only demonstrated resilience but also delivered the second-highest compounded returns, outperforming most asset classes. Additionally, an April 2024 Allianz report highlights how private credit has maintained its resilience even in the face of rising interest rates that began in early 2022. While US Investment Grade and High Yield corporate bonds experienced increased default rates—especially in the High Yield sector—private credit default rates remained largely unaffected. This uncorrelated performance underpins private credit's market neutrality and stable risk profile, making it a particularly robust asset class amidst economic fluctuations.
Private credit, as seen in the graph, is expected to experience a remarkable compound annual growth rate (CAGR) of 11.1% from 2023 to 2028. This increase might lead to assets under management (AUM) potentially reaching $2.8 trillion by the end of that year.
The private credit market is evolving differently across the U.S., Europe, and Asia, offering lending options not available in public or bank markets. In the U.S., around 30% of the market’s borrowing needs are met by banks, while this figure is about 40% in Europe and closer to 80% in Asia. This heavy reliance on banks in Asia creates a significant funding gap, particularly for SMEs, which struggle to secure financing through traditional channels. Banks typically require a sufficient track record, profitability, hard collateral, and personal guarantees—criteria that many smaller and growing businesses may not meet. This gap underscores the critical role of private credit in addressing these unmet financing needs and presents a substantial opportunity for private credit investors, especially in regions like Southeast Asia and India, to bridge the void left by banks.
In Asia, banks typically serve top-tier companies. These investments are often tied to supply chain and trade finance, particularly for companies with clear cash flow and liquid collateral. Private credit plays a crucial role in providing financing for SMEs, highlighting the importance of private credit in the region.
As the global financial landscape continues to shift, the importance of diversification, risk management, and strategic allocation cannot be overstated. The recent market volatility has prompted investors to re-evaluate traditional portfolio models and explore alternative assets such as private credit. Meanwhile, private credit is gaining traction as a stabiliser in volatile markets, offering a steady income stream and resilience that can help investors navigate the challenges ahead. In an era of rapid change, adapting to these new dynamics is crucial for maintaining and growing wealth.
1.https://www.investing.com/news/stock-market-news/what-happens-after-a-big-spike-in-the-vix-3565886 2.https://www.cnbc.com/2020/03/16/wall-streets-fear-gauge-hits-highest-level-ever.html 3.Historical Data Vix https://finance.yahoo.com/quote/%5EVIX/history/ 4.https://www.barrons.com/articles/economy-stock-market-torsten-slok-b7bad3a7?mod=hp_minor_pos22 5.https://www.spglobal.com/ratings/en/research/articles/240729-credit-trends-global-financing-conditions-early-issuance-should-support-growth-through-second-half-slowdown-13193529 6.https://www.pimco.com.au/en-au/insights/economic-and-market-commentary/general/preparing-for-market-volatility-why-bonds-should-be-a-key-component-of-portfolios-today/ 7.https://www.linkedin.com/pulse/exploring-potential-private-debt-investment-generali-investments-lsa7f/ 8.https://www.nuveen.com/global/insights/equilibrium 9.https://www.financeasia.com/article/dbss-clifford-lee-on-asias-private-credit-opportunity/495515 10.https://www.pwchk.com/en/asset-management/navigating-the-region-apr2024.pdf 11.https://www.pwc.com/sg/en/insights/assets/docs/risk-regulatory-outlook-2021-basel-iii-finalisation.pdf 12.https://www.kkr.com/insights/asia-pacific-credit-sweet-spot