Rhythmic Reasoning_Full Report_Final_EN - Flipbook - Page 49
THE DRUMMER'S EAR | RHYTHMIC REASONING
front through the first half of the year, the momentum is expected
to carry through into the second half of 2025 and into 2026 (Fig.
3). As we mentioned earlier, recession risk also remains low, and
while labour markets have begun to show some cracks, lower policy
rates could help stabilize economic conditions and keep recession
fears at bay. All else equal, an environment of lower policy rates,
coupled with positive, albeit moderating economic growth should
be supportive of corporate profit expansion and risk assets.
spreads for both rating buckets are below the long-term historical
average, but the high-yield segment of the market is more prone
to spread widening if economic conditions falter (Fig. 5).
Fig. 5: Credit spreads are below their long-term historical average
489
20-yr. avg.
Fig. 3: Earnings growth estimates for this year and
next remain healthy across the major equity markets
Current
267
18%
148
74
12%
High yield
Investment grade
6%
Additionally, high-yield issuers have historically driven the bulk of
defaults while investment-grade borrowers seldom default (Fig. 6).
0%
U.S.
International
2025
Canada
Mexico
2026
Fig. 6: High yield issuers have historically defaulted
more often than their investment grade counterparts
Within fixed income, we maintain our allocation to high-quality
assets, including sovereign debt and investment-grade corporate
credit. High-quality fixed income can serve as a safe harbour for
investors, acting as a ballast in portfolios if the labour market
softness emerging in economies like the U.S., Canada, and the U.K.
transforms into widespread job losses that trigger a recession and
cause market volatility to ramp up. Developed market government
bond yields are also hovering near multi-year highs – both on a
nominal and real basis – in response to sticky inflation in many
parts of the world and concerns over worsening fiscal imbalances
(Fig. 4).
Fig. 4: Sovereign bonds remain a valuable source
of attractive income and can provide protection in
the event of an unexpected economic slowdown
12%
9%
6%
3%
0%
1981
1987
1993
Overall default rate
1999
2005
IG default rate
2011
2017
2023
HY default rate
Source: S&P Global, Scotia Wealth Management
Of course, this is not to say that investors should forego exposure
to the high-yield asset class all together. Selectivity is important
as credit risk varies significantly across rating tiers. Lower-rated
issuers, such as those rated CCC, carry a much higher probability of
default compared to the upper-echelon of the high-yield segment
(Fig. 7). Careful security selection can help balance return potential
with default risk.
6%
4%
2%
0%
-2%
2007
2013
U.S. 10-yr nominal yield
2019
2025
U.S. 10-yr real yield
Source: Bloomberg Finance LP, Scotia Wealth Management
Consistent with our preference for quality, we remain underweight
high yield credit in favour of investment-grade credit. Credit
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