According to a research report by Jim Reid of Deutsche Bank, the 5 year cumulative default rate for US High Yield names will hit 53% assuming 0 recovery rates, and 69% assuming average recoveries. In Europe things are even worse: 65% and 81% respectively.
The 53% compares to a 45% default rate during the Great Depression, implying the credit market is anticipating a period of economic hardship over the next 5 years even worse than the "roaring" (for bankruptcy lawyers) 30's. Not surprisingly, default probabilities are again tied in to real estate valuations:
“We expect a continued fall in prices for one to two years in the U.S. and
longer in the U.K. and Europe." Reid wrote. The property market is "crucial to
consumer spending, the health of banks and the overall economy. The story is
certainly not over."
This may add more fire to the ongoing debate about the bifurcation between equities and credit, especially lower rated credit. As noted earlier, equities, unlike credit spreads, are trading at record trailing P&E's. Could this simply mean that hope, naivete and wide-eyed wonder are the key qualities of equity market participants, while anger, fear, aggression are traits of credit traders? Probably yes. Who is correct - again, one that likely will be answered relatively promptly.
hat tip hornai trader