Guggenheim CIO Says Credit Market Is ‘Next Shoe to Drop’

(Bloomberg) — While calls for a soft-landing are piling up on Wall Street, Anne Walsh is staying on the defensive.

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The chief investment officer of Guggenheim Partners Investment Management, which manages more than $225 billion, is hiding out in high quality bonds while bracing for lower quality parts of the credit market to get hit.

“I don’t think the market is really pricing in the next shoe to drop, and that’s credit,” she said on Bloomberg Television. “Recession seems to be off everybody’s mind, but I think that’s probably a mistake at this point in time.”

Walsh sees lower-quality borrowers at risk with the prospect of a higher-for-longer Federal Reserve and rising downgrades, defaults and bankruptcies.

Higher quality credit is less of a concern. Yields over 5.5% on investment grade bonds are “attractive,” and the spread widening that happens in recessions is not likely to have a big impact on that space, she explained.

“For those borrowers and credit takers who have cash and have the wherewithal for repayment right now, they’re going to come through the cycle pretty well,” she said.

“The problem is the weaker credits, those that don’t have a lot of cash sitting on the sidelines,” Walsh said. “They’re not able to offset these higher costs of capital with reinvestment in cash instruments.”

Walsh also likes US government bonds, as yields have remained in a relatively stable trading range and offer investors the opportunity to wait on the sidelines, investing in lower rated credit in the future if spreads get more attractive.

“I think it’s a really good time to be defensive and thoughtful and wait for the next opportunity set,” said the CIO.

Walsh expects the US recession to be a “rolling one,” where different parts of the economy are hit and other, stronger capitalized parts are spared. She also highlighted that the market hasn’t yet reacted to the commercial real estate cycle, where the cost of leverage is still high for borrowers and some tenants are vulnerable.

“If you are a small developer who owns a handful of small office buildings in a suburban location, and you’re now paying 6% for your debt, and all of a sudden your tenants are starting to walk out the door, now you’ve got a problem,” Walsh said in a separate interview.

She will be closely assessing the health of consumer spending over the next several months to determine the extent of policy tightening working its way through the economy.

She also said that while Thursday’s CPI print means the Federal Reserve is done hiking interest rates, the central bank is still tightening through shrinking its balance sheet.

“I think we’re done with the hikes right now, but then there’s QT still going on,” said Walsh. “Don’t ignore that.”

–With assistance from Alix Steel.