Fewer Defaults Strongly Favor a Higher Equity Market

WEEKLY MARKET OUTLOOK MAY 31, 2018 CAPITAL MARKETS RESEARCH Moody’s Analytics markets and distributes all Moody’s Capital Markets Research, Inc. materials. Moody’s Capital Markets Research, Inc is a subsidiary of Moody’s Corporation. Moody’s Analytics does not provide investment advisory services or products. For further detail, please see the last page. Fewer Defaults Strongly Favor a Higher Equity Market Credit Markets Review and Outlook by John Lonski Fewer Defaults Strongly Favor a Higher Equity Market » FULL STORY PAGE 2 The Week Ahead We preview economic reports and forecasts from the US, UK/Europe, and Asia/Pacific regions. » FULL STORY PAGE 5 The Long View Full updated stories and key credit market metrics: May’s US$-denominated corporate bond offerings plunged by 30% annually in response to a 68 basis point jump by the 10-year Treasury yield to 2.98%. » FULL STORY PAGE 11 Ratings Round-Up Latest U.S. Rating Changes Are All in the Utility Sector » FULL STORY PAGE 15 Market Data Credit spreads, CDS movers, issuance. » FULL STORY PAGE 17 Moody’s Capital Markets Research recent publications Links to commentaries on: Higher rates, profit growth, credit quality, default rates, foreign investors, internal funds, tariffs, borrowing restraint, corporate bonds, tax law changes, stocks and spreads, Greek drama, South Korea, Brazil sovereign credit. » FULL STORY PAGE 22 Credit Spreads Investment Grade: We see year-end 2018’s average investment grade bond spreads exceeding its recent 124 bp. High Yield: Compared to a recent 377 bp, the high-yield spread may approximate 425 bp by year-end 2018. Defaults US HY default rate: Moody's Default and Ratings Analytics team forecasts that the U.S.' trailing 12-month high-yield default rate will sink from April 2018’s 3.7% to 1.5% by April 2019. Issuance In 2017, US$-denominated IG bond issuance grew by 6.8% to a record $1.508 trillion, while US$-priced high-yield bond issuance advanced by 33.0% to a new record calendar-year high of $453 billion. For 2018’s US$-denominated corporate bonds, IG bond issuance may drop by 7.1% to $1.401 trillion, while high-yield bond issuance is likely to fall by 9.0% to $412 billion.. Click here for Moody’s Credit Outlook, our sister publication containing Moody’s rating agency analysis of recent news events, summaries of recent rating changes, and summaries of recent research. Moody’s Analytics Research Weekly Market Outlook Contributors: John Lonski 1.212.553.7144 john.lonski@moodys.com Franklin Kim 1.212.553.4419 franklin.kim@moodys.com Yuki Choi 1.212.553.0906 yukyung.choi@moodys.com Moody’s Analytics/U.S.: Ryan Sweet 1.610.235.5213 ryan.sweet@moodys.com Kathryn Asher 1.610.235.5176 kathryn.asher@moodys.com Michael Ferlez 1.610.235.5162 michale.ferlez@moodys.com Moody's Analytics/Europe: Barbara Teixeira Arajuo +420.224.106.438 barbara.teixeiraarajuo@moodys.com Moody's Analytics/Asia-Pacific: Katrina Ell +61.2. 9270.8144 katrina.ell@moodys.com Alaistair Chan +61.2. 9270.8148 alaistair.chan@moodys.com Veasna Kong +61.2. 9270.8159 veasna.kong@moodys.com Faraz Syed +61.2. 9270.8146 faraz.syed@moodys.com CAPITAL MARKETS RESEARCH 2 MAY 31, 2018 CAPITAL MARKETS RESEARCH / MARKET OUTLOOK / MOODYS.COM Credit Markets Review and Outlook Credit Markets Review and Outlook By John Lonski, Chief Economist, Moody’s Capital Markets Research, Inc. Fewer Defaults Strongly Favor a Higher Equity Market Notwithstanding the occasional jarring setback, the market value of U.S. common stock need only rise by 4.8% in order to return to its record high of January 26, 2018. Such a recovery appears to be well within reach if profits grow. Moreover, the realization of the projected decline by the U.S.’ high-yield default rate from April 2018’s 3.7% to 1.5% by April 2019 implies a firming of corporate finances that can only facilitate a recovery by share prices. For each of 130 year-to-year declines by the high-yield default rate since 1994, the market value of U.S. common stock (as measured by the Dow Jones Total Stock Market index) was up from its year-earlier value. Roughly 88% of the 209 year-to-year declines by the high-yield default rate since June 1985 have been accompanied by a yearly increase for the market value of U.S. common stock. The medians for the year-to-year changes of this sample are -1.5 percentage points for the default rate and +13.4% for the market value of common equity. However, the 209 yearly declines by the default rate hardly show a monotonic relationship with the yearly percent change of the market value of common stock. For example, when the range of the default rate’s annual decline deepens from 0.7 to 1.0 percentage point to 2.0 to 2.5 percentage points, the average percent increase for the market value of common stock paradoxically slows from 13.9% to 8.2%. Nevertheless, when the default rate’s annual drop is deepe