Recent Credit Stress a Canary in the Coal Mine?

While idiosyncratic credit risk is beginning to emerge, signs of broader credit or systemic stress are still sparse.

The recent collapse of First Brands and Tricolor Auto Group, together with loan losses among some U.S. regional banks, have begun to stir fears over broader credit markets and spillover risks to other assets.

To be sure, credit is an area we continue to watch closely, for good reason. Stress in corporate bond markets is often seen as a canary in the coal mine for broader risk assets. Examples include early 2000 before the dotcom crash; in 2007, running up to the Global Financial Crisis; the 2015 – 16 energy debacle; late 2018 preceding the Federal Reserve’s ‘pivot’; and, most recently, during the 2021 – 22 inflation shock. In each instance, meaningfully wider index credit spreads presaged equity drawdowns by one to four months.

Notwithstanding recent headlines around credit concerns and some idiosyncratic stress in racier segments of credit like leveraged loans, we detect few if any signs of broader credit or indeed systemic stress. Most index spread markets are comfortably within (or through) the lowest quintile of history. Put differently, the first smell test of meaningful widening in spreads is not met.

Importantly, there also doesn’t appear to be a clear catalyst on the horizon. Corporate balance sheets are robust (see chart), economic growth is poised to gently accelerate, and liquidity conditions are healthy, helped by broadly easing bias to both monetary and fiscal policy.

The Need for Perspective

From a bottom-up perspective, our fixed income team recently described why First Brands and Tricolor were ‘bad apples’ with limited broad read-across. They make a similar argument of idiosyncrasy on recent non-bank financial institution (NBFI) loan losses among some U.S. regional banks, where names that came under pressure did not benefit from solid capital and reserve coverage ratios (which comfortably exceed 2023 levels, for example), firm earnings and solid asset quality. Although NBFI lending from banks has doubled since 2020 and is the fastest-growing segment of bank loans, this exposure seems manageable in our view—certainly for the larger, typically investment-grade institutions. Indeed, we do not believe this is a meaningful risk given the health of overall balance sheets of the companies NBFIs lend to.

Meanwhile, from the top-down perspective of an asset allocator, it is difficult to discern real signs of stress in credit more widely. Broad option-adjusted spread levels for riskier high yield and higher quality corporate investment grade bonds remain tight, and well within or even through the lowest quintile across the main regional blocks (including the U.S., Europe and Asia).

Drilling deeper into spreads by ratings and sectors leads to a similar conclusion. The riskiest spreads (on bonds rated Caa/CCC by Moody’s and Standard & Poor’s) in high yield have moved only modestly in the U.S. and Europe. Spreads in racier corners of the investment grade universe captured by Baa/BBB-rated bonds have barely budged. In addition, duration-adjusted lenses continue to show tight compensation per unit of duration.

Given the relevance of the (il)liquidity component of corporate bonds in judging spread risk, simple measures of liquidity like the deviation from net asset value of major credit ETFs also paint a sanguine picture.

This being said, some relative moves between segments of credit do bear watching. Such areas include the resilience of Ba/BB-rated credit against weakness in Caa/CCC-rated credit, the more intense pressure on business development companies (BDCs) compared with CCC-rated companies,¹ and stress in the leveraged loan market. So far, this has tended to be company- or sector-specific. For example, stress in leveraged loans and BDCs is concentrated in sectors like technology that are facing disruption from AI. And note that at a very high level, what works well for equities (such as deepening investment in AI) can often hurt credit.

Reasons to Be Constructive

As earnings season progresses at a healthy clip, we are encouraged by the continued strength of corporate earnings and balance sheets. At the aggregate level, most measures of corporate debt sustainability have actually improved meaningfully over the last five years. Companies have used the combination of low interest rates and surging post-pandemic profits to tidy up their balance sheets across almost every conceivable metric (see chart).

The macro setting, meanwhile, is also expected to remain supportive for both credit and equity, with global economic growth and corporate earnings poised to gently accelerate, and with healthy liquidity conditions helped by a broadly easing bias of both monetary and fiscal policy. It usually takes a recession and/or widespread balance sheet excesses to produce a default cycle, and with monetary policy easing, the headwinds from higher borrowing costs are more likely to be in the rearview mirror than up front.

As such, looking ahead to the next six to 18 months, our asset allocation portfolios continue to tilt positively, if selectively, toward risky assets like equities—with a focus on U.S. small caps, Japan and China—and fixed income, particularly non-U.S. investment grade corporate bonds (chiefly in Europe) and emerging market local hard currency bonds. What’s more, while vigilant of credit risk, we continue to view any spread- or duration-widening in select areas of fixed income as an opportunity to increase exposure.

U.S. Corporate Fundamentals Look Robust

Percentile Rank of Distribution since 1950

Source: Absolute Strategy Research. Data as of October 22, 2025. Nothing herein constitutes a prediction or projection of future events or future market behavior. Historical trends do not imply, forecast or guarantee future results. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed or any historical results. Past performance is no guarantee of future results.