Jim Cielinski: First and foremost, the cycle still looks bearish. But the big change has been the peak in inflation, and this is critical for two reasons. Central banks overtightening would likely raise real rates and really preclude companies from being able to borrow easily. Secondly, that is what will produce a hard landing. The earnings shock that we feared was more likely given a dramatic overtightening. So as inflation recedes, I think central banks can start to become a bit more friendly and perhaps avoid the serious mistakes that will push us into a deep and hard landing.

Credit fundamentals have actually remained relatively robust. They’ve been getting softer, and it’s important to realize that earnings are coming down; they’re going to come down more. There will be pressure on credit fundamentals as we go through the year. Defaults will pick up and the number of distressed credits will pick up. I think the severity of that is dependent on the hard landing versus soft landing argument. The market is pricing in a soft landing, so it’s no time to get complacent. I think earnings and fundamentals, as they weaken, will often prompt a narrative shift, so be on the lookout for that.

One question we get a lot is, “How do we navigate this part of the cycle?” When a lot is contingent upon whether you get a hard landing or a soft landing, it makes it really difficult, because that is often a function of policy mistakes. It can be geopolitical risk. There are a lot of different moving parts, and I think keeping an eye on key drivers is number one. I think looking at where you get protection – more defensive earnings streams, less cyclicality, less geopolitical risk. All of these things, I think, can help investors still get the nice yields that credit offers but without really overexposing themselves to the economic risk and the cyclicality risk that so much of the credit market actually presents.

One of the things we ask ourselves a lot around inflection points in the cycle is, what are the signposts to be on the lookout for? If you wait too long, you’re going to miss the rally. For us, inflation was one of those signposts, and I think the peak there is important. The second element though is that central banks may have still done too much. We need to see money supply begin to accelerate. We need to see some of the very weak responses from manufacturers begin to dissipate – purchasing manager surveys are negative. And then we need to see credit creation and consumption stabilize at these levels. We don’t expect it to skyrocket, but there are still a number of pressures out there that we think are worsening, and just mere stabilization – along with friendlier central banks – will be enough for us to say that the cycle could be turning.

What’s the prognosis for returns in the coming year? Think of last year as one in which both credit spreads widened and interest rates went higher. So total returns were dismal. The advantage this year will be that either one of those two things working in your favor, or less against you, could produce much nicer returns. I think duration looks attractive; interest rates are at much higher levels. You could get decent total returns now even in a slowdown, and that’s an attractive feature.

For credit spreads, the starting yield is so much more attractive; you’re getting a nice cushion that leaves some probability of a harder recession priced in. That’s important because there is a lot of risk in the price. For me, returns this year look so much more attractive than they did just a year ago. That’s the argument, that as things being to recede a bit on the risk front, you don’t want to wait too long to get back into credit.

Among the main themes in 2023 we’d expect to see is dispersion. Dispersion across different parts of the credit market, different industries, different qualities having very different reactions to the economic backdrop. Dispersion across developed and emerging. Emerging was one of the first categories to actually sink a year or a year-and-a-half ago. It will one of the first to emerge as the dollar weakens, as they are able to retreat from their tightening. I think emerging markets look very attractive. I also think areas where there is no supply. Some industries, but in particular, say, the sterling bond market, looks like it will have a very good supply/demand imbalance in favor of higher prices. These are all the technical factors that you must, I think, combine with the fundamentals at this stage of the cycle to really successfully navigate what’s happening.