The credit market appears healthy based on tight average spreads, but this is misleading. A strong top 90% of the market pulls the average down, while the bottom 10% faces severe distress, with loans "dropping like a stone." The weight of prolonged high borrowing costs is creating a clear divide between healthy and struggling companies.

While default risk exists, the more pressing problem for credit investors is a severe supply-demand imbalance. A shortage of new M&A and corporate issuance, combined with massive sideline capital (e.g., $8T in money markets), keeps spreads historically tight and makes finding attractive opportunities the main challenge.

In the post-zero-interest-rate era, the “everything rally” driven by liquidity is over. Higher base rates mean companies must demonstrate fundamental strength, not just ride a market wave. This environment rewards active managers who can perform deep credit selection, as weaker credits no longer outperform by default.

The market is focused on potential rate cuts, but the true opportunity for credit investors is in the numerous corporate and real estate capital structures designed for a zero-rate world. These are unsustainable at today's normalized rates, meaning the full impact of past hikes is still unfolding.

The expected wave of M&A and LBOs has not materialized, leaving the deal pipeline thin. This lack of new debt supply provides a strong supportive backdrop for credit spreads, allowing the market to absorb geopolitical volatility more easily than fundamentals would otherwise suggest.

Judging the credit market by its overall index spread is misleading. The significant gap between the tightest and widest spreads (high dispersion) reveals that the market is rewarding quality and punishing uncertainty. This makes individual credit selection far more important than a top-down market view.

Instead of an imminent collapse, the credit market is likely poised for a final surge in risk-taking. A combination of AI enthusiasm, Fed easing, and fiscal spending will probably drive markets higher and fuel more corporate debt issuance. This growth in leverage will sow the seeds for the eventual downturn.

In a market where spreads are tight and technicals prevent sustained sell-offs, making large directional bets is a poor strategy. The best approach is to stay close to benchmarks in terms of overall risk and allocate the risk budget to identifying specific winners and losers through deep, fundamental credit analysis.

Barclays' research shows that the best investment performance comes from combining fundamental analysts with systematic signals. The key is to filter out trades where the two perspectives diverge, as this method is exceptionally effective at eliminating potential losing investments and generating alpha.