Accept what you can’t control, master what you can

February 7, 2025

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Investors worried about rising uncertainty may consider an allocation to short-duration credit, argues Tatjana Greil-Castro.

There are things we cannot know, no matter how much data we crunch or how many research reports we read. Accepting what is unknowable allows us to focus on aspects we can quantify and thereby make informed decisions.

This is especially true of investing. In theory, valuations should reflect a reasonable degree of confidence about the potential upside and downside risk of an investment. Or, to put it another way, how much uncertainty are you prepared to accept to make a new investment or stay invested?

How tolerant are you?

Investors in riskier asset classes such as equities or cryptocurrencies need to have a higher tolerance for uncertainty. While it easy to get caught up in the excitement of a bull run in a stock or sector, it is important to remember that things can turn in a heartbeat.

After 2 years of 20%+ returns in US equities,[1] recent developments in the US artificial intelligence sector highlight that stock prices can and do move sharply in both directions. Reports that a previously unknown Chinese startup DeepSeek has built a large language model at a fraction of the cost of US platforms has raised concerns about AI hype and one company in particular. On January 27, Nvidia shares plunged 16.97%, wiping out almost US$600 billion of its market capitalization, the biggest single day fall ever for a US company.

Stock market downturns are often unexpected, happen rapidly, and take years to recover from. Perhaps the most relevant example for today’s tech-dominated US stock market was the bursting of the dotcom bubble in the early 2000s. After falling 75% between March 2000 and October 2002, it took the Nasdaq 15 years to fully recover.[2]

Double jeopardy

Credit investors have to navigate uncertainty, too, a major source of which currently stems from the new US administration. Already this year, we have seen much angst over US tariffs. One moment, markets are trying to assess the impact of 25% additional tariffs on imports from Canada and Mexico; the next, we hear that tariff hikes are on pause for a month.[3]

The longer-term consequences of other shifts in US policy, including to immigration and deregulation, are equally difficult to quantify. Maybe they will prove positive for US growth and domestically focused businesses. But they could also be inflationary and have a significant impact on US interest rates and the value of financial assets.

No-one knows for sure how things will play out; however, unlike equities or crypto, credit investors can at least fall back on basic bond maths. We can calculate how much cushion exists in various parts of the credit curve before any increase in yields or spreads begins to negatively impact returns.

Announcements from Washington could cause volatility at various points, but they are unlikely to cause a wave of defaults to bonds issued by high-quality investment-grade and high-yield companies in the near term. Investors in bonds maturing over the next 1-3 years should, therefore, be confident they will continue to collect coupons and be repaid in full when the bonds mature.

Safety in numbers?

This is reflected in breakevens (a measure of how much yields or spreads would have to rise before returns become negative) across the credit curve. As Figure 1 highlights, the increase in yields over the past three years has led to a commensurate rise in breakevens across all parts of the US credit curve.

However, the level of cushion against rising yields and spreads is considerably greater in the 1-3-year part of the curve – around 2.7% - and diminishes the further out you go. A similar narrative is playing out in the European and sterling markets.

Figure 1: Breakevens in US credit

Source: ICE Data Platform, as of 31st December, 2024 and 31st December, 2021. ICE BofA 1-3 / 3-5 / 5-7 / 7-10 / 10-15 / 15+ Year US Corporate Index (C1A0 / C2A0 / C3A0 / C4A0 / C7A0 / C8A0). ICE BofA BB-B US Cash Pay High Yield Index (J0A4). Indices selected provide proxy for highlighting breakevens over various maturities in the US investment-grade market. For illustrative purposes only.  

There are no ‘sure things’ in the investment universe. While there will be periods in which the stars align and there are opportunities to ‘make hay’, there are other times when greater uncertainty justifies a more pragmatic approach.

Investors with a low tolerance for uncertainty and higher appetite for control may find what they are looking for in higher-quality, short-duration credit.

 

References

[1] Financial Times, ‘US stocks soar more than 20% for second year in a row,’ December 31, 2024
[2] Corporate Finance Institute, ‘Dotcom Bubble,’ January 2025
[3] Bloomberg, ‘It’s Almost Like They Knew Trump Was Bluffing,’ February 4, 2025

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of February 2025, and may change without notice.

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Index descriptions

C1A0 - The ICE BofA  1-3 Year US Corporate Index is a subset of the ICE BofA  US Corporate Index (C0A0) including all securities with a remaining term to final maturity greater than or equal to 1 years and less than 3 years.

C2A0 - The ICE BofA  3-5 Year US Corporate Index is a subset of the ICE BofA  US Corporate Index (C0A0) including all securities with a remaining term to final maturity greater than or equal to 3 years and less than 5 years.

C3A0 - The ICE BofA  5-7 Year US Corporate Index is a subset of the ICE BofA  US Corporate Index (C0A0) including all securities with a remaining term to final maturity greater than or equal to 5 years and less than 7 years.

C4A0 - The ICE BofA  7-10 Year US Corporate Index is a subset of the ICE BofA  US Corporate Index (C0A0) including all securities with a remaining term to final maturity greater than or equal to 7 years and less than 10 years.

C7A0 - The ICE BofA  10-15 Year US Corporate Index is a subset of the ICE BofA  US Corporate Index (C0A0) including all securities with a remaining term to final maturity greater than or equal to 10 years and less than 15 years. 

C8A0 – The ICE BofA  15+ Year US Corporate Index is a subset of the ICE BofA  US Corporate Index (C0A0) including all securities with a remaining term to final maturity greater than or equal to 15 years.

J0A4 - The ICE BofA  BB-B US Cash Pay High Yield Index is a subset of the ICE BofA  US Cash Pay High Yield Index (J0A0) including all securities rated BB1 through B3, inclusive.

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