Expansion
During an expansion, companies tend to see profits increase, leading to upgrades in riskier areas of the credit market, such as high yield and leveraged loans. At the height of the expansion, direct lending benefits the most and has historically led in terms of returns among credit.
Late cycle cooling
As the economy begins to cool, Treasuries, investment grade and direct lending can be good sources of downside protection. Although high yield has historically remained resilient, weaker quality companies emerge from the “turnaround” in relatively strong health.
Recession
When the economy is in a recession, the contraction in economic growth pushes the weakest companies into default and downgrades riskier areas of the credit market. As such, high yield and leveraged loans tend to underperform, while higher quality credit such as Treasuries, investment grade and direct lending remain more resilient during times of economic stress.
Turnaround
As the economy emerges from a recession (“turnaround”), the outlook for credit downgrades and defaults improves and investors find opportunities further out on the risk spectrum in areas like high yield and leveraged loans. Usually the recession pushes the weakest companies into the default and downgrades weaker areas of the investment grade market, and lending standards tighten, so the high yield and leveraged loans sectors have typically actually moved up overall in quality, and should benefit from improving economic conditions and credit markets.
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