KBRA Financial Intelligence

3 Things in Credit: Bulls’ Run, Politics of Rates, Aviation

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.

I’m coming to you from what’s now known as a “heat dome,” previously known simply as a summer’s day. It’s also midyear outlook time and a sampling of titles from various sources has always been an interesting exercise. In the latest batch, we notice a common thread of caution. From J.P. Morgan’s private bank: “A strong economy in a fragile world.” From Apollo: “An unstable economic equilibrium.” From Wells Fargo: “Approaching the economy’s pivot point.” From Deutsche Bank: “Optimism with uncertainties ahead.”

Feels like we’re still hedging our bets.

This week, our 3 Things are:

1. Running of the bulls. Momentum is a tough thing to stop.

2. Politics and rates. The interplay has some dark undertones.

3. Aviation. Has it normalized?

Alright, let’s dig a bit deeper.

Running of the bulls. This week, we hit the 31st record high in the S&P 500 this year. We also saw a number of Street strategists take, if not gap, their year-end estimates for said index higher. Of the 21 strats surveyed by Bloomberg, eight took their estimates up during the past month; zero took it down. The median call for the S&P for the group is now 5,450—that’s 5% higher than last month and 12% above where the group was last year-end.

Interestingly, it’s all on multiple expansion. The median earnings per share estimate, $240, didn’t move in the last month and is up less than half of 1% from last year-end. That said, 11 of the prognosticators expect the S&P to fall by year-end; 10 expect it to rise.

This comes at a time when the economy is clearly slowing. I know, I know, the market is not the economy. But still. The Citi Economic Surprise Index has been in negative territory for six weeks now and it has hit its lowest point since the summer of 2022. And some of the more noteworthy economic bulls are capitulating. Goldman, whose U.S. GDP forecast has been notably above consensus, has flipped: “GDP growth has slowed meaningfully, from 4.1% in 2H 2023 to an estimated 1.7% in 1H 2024. Real income growth has softened, consumer sentiment has fallen anew, and there are early signs of an increase in election-related uncertainty that could weigh on business investment in coming months.”

Perspective is important here, however. GS is still calling for above-potential U.S. growth this year of 2.5%, which is still a tick above the Bloomberg consensus of 2.4%. But we are slowing. And maybe, just maybe, credit is leading the way. IG spreads are out 9 bps from its recent low of May 6, and high yield is out 26 bps. It may be time to curb our enthusiasm.

Alright, on to our second Thing—Politics and rates.

Over the past couple of years, market participants and economists have struggled to reconcile a strongly performing economy with at times dismal consumer sentiment surveys. The two most familiar—University of Michigan’s Consumer Sentiment Index and the Conference Board’s Consumer Confidence Index—have differing points of orientation. Michigan’s is more focused on financial security/wherewithal, while the Conference Board’s weighs job prospects more heavily. Not surprisingly, the Conference Board’s has been more durable through the post-pandemic era as the jobs market has been tight.

Both have trended lower over the past three years, with Michigan’s hitting an all-time low in June 2022, before bouncing a bit. We have attributed the falloffs to inflation and the bitter political divide. Turns out people really hate inflation, regardless of what’s happening to wages, which ironically have more than kept up. And on the political front, it’s hard to escape the social media and cable news vitriol that constantly reminds you, with little regard for facts, just how bad things are.

I came across a piece this week by two of my favorite observers, current New York Times columnist and former Wall Street Journal columnist Bret Stephens and Ruchir Sharma, CIO and Founder of Breakout Capital and former Chief Global Strategist of Morgan Stanley Investment Management. Stephens notes that approval ratings for G7 leaders have rarely, if ever, been lower, and that one survey found that only 20% of people in the G7 thought their families would be better off in five years. Pretty sobering.

Mr. Sharma attributes the broad dissatisfaction in part to the zero interest rate policy that propelled the value of investments in stocks and homes—the things largely owned by the rich—to record highs. That, in turn, had two undesirable effects. It fueled wealth inequality, and it grew and preserved zombie companies. Furthermore, the public policy and private sector response—tightening credit—hit the more vulnerable population, something we continue to highlight as part of our “Two Economies” narrative. Where does it end? Mr. Stephens observes: “The social consequence is rage; the political consequence is populism.”

What does this have to do with credit? It suggests a path to a harder-landing scenario, where the more vulnerable of our Two Economies becomes a material drag on the stronger one. The European political drama we’re seeing take root fits this scenario, as does the Goldman Sachs economics research referenced above.

It is worth keeping an eye on this when thinking about 2025.

Alright, on to our third Thing—Aviation taking off.

We’ve long wondered why aviation and airline credit was so out of favor in the post-pandemic era. Clearly, these sectors were beneficiaries of revenge travel and the return of lucrative business and international flights. This week, we tripped across a few anecdotes that suggest the sector, selectively, is back.

First off, in its outlook released this month, the International Air Transport Association boldly, if not belatedly, proclaims that the industry “can now turn the page on the COVID pandemic.” Traffic has returned to pre-pandemic levels and the industry has returned to profitability. Overall, the Association forecasts airline profitability to reach $30.5 billion in 2024, 11% better than 2023, on improved but still skinny margins of 3% and positive operating leverage. The industry’s revenue is expected to reach a record $996 billion in 2024—that’s nearly 10% above 2023’s level.

Next up, we noticed that Delta Air Lines has the highest percentage of analyst “Buy” ratings on its stock (95%) of any company in the S&P 500, tied with names you might suspect—Microsoft and Amazon. So, it should come as no surprise then that Delta five-year CDS has ripped in 150 bps from its recent wides in October 2023 to 135 bps today. Its 3.75% of 2029 bonds are yielding 5.4%, with an OAS of 114 bps, right on top of the BBB index. Split rated, Delta certainly reads like a rising star.

We also noticed renewed life in aviation ABS, with the first deal in two years from Carlyle Aviation Partners and the premarketing of another transaction announced by PK AirFinance. And finally, Aviation Capital Group printed $600 million of a five-year priced to yield 5.547% at a spread of 130 bps, 20 bps inside of initial price talk. That deal follows a $1.2 billion two-part Air Lease deal, with both tranches (a two-year and a seven-year) priced well inside guidance. All in all, one more thing that has normalized.

So, there you have it, 3 Things in Credit:

1. Running of the bulls. Credit’s turned, will stocks?

2. Politics and rates. Maybe it’s time for Chair Powell to reprise his pain speech.

3. Aviation. It’s back in favor.

As always, thanks for joining. We’ll see you next week.