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BlackRock Is Shrinking U.S. Credit Bets -- These Charts Show Why

BlackRock Inc. downgraded U.S. credit to neutral from overweight this week, saying it prefers equities instead.

Investors are facing an “increased vulnerability to downside risk,” Jeff Rosenberg, chief fixed income strategist at BlackRock, said in an interview on Tuesday. He’s concerned investor compensation is shrinking just as credit quality and protections are deteriorating and borrowers are milking every advantage. “The erosion in credit quality, covenants, Ebitda quality and add-backs are all anecdotal examples of late-cycle credit behavior,” he said.

These three charts help show why the world’s largest money manager is cooling to credit:

1. Credit spreads have tightened around the globe. The extra premium investors demand to own riskier corporate debt over U.S. government bonds is at the narrow end of a 17-year range. Tight spreads leave little safety cushion against rising interest rates or an increase in default risk.

2. A lot of investors have been rushing into credit. BlackRock says the market is running at “relatively hot levels, versus a more neutral stance in U.S. equities compared with recent history.” That could make for a crowded exit should sentiment sour.

3. Credit quality has been eroding in pockets of the debt market. The evidence for that is seen in deteriorating investor protections and the rise of borrower-friendly tactics such as add-backs, which allow companies to “inflate some measures of earnings and thus creditworthiness,” Richard Turnill, the firm’s global chief investment strategist, wrote in a note to clients on Oct. 23.

— With assistance by Lisa Lee, and Sally Bakewell

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