Performing Credit Quarterly 4Q2023: The Goldilocks Trap

The prevailing market narrative for the coming year demands a level of optimism that may be bordering on credulousness. The U.S. economy is expected to be neither too hot nor too cold, and the Federal Reserve is projected to begin cutting interest rates meaningfully without there being a recession or other crisis. In other words, everything is expected to be “just right.” While this could happen, we believe – to quote our co-chairman Howard Marks – that this all “smacks of Goldilocks thinking.”

We acknowledge that there are several good reasons for this optimism, namely the rapid decline in U.S. inflation in 2023 and the country’s surprisingly resilient economy. However, we still think investors should proceed with caution, given how much Goldilocks thinking appears to be reflected in today’s asset prices. It’s notable that we saw rallies in both risk and duration in the fourth quarter: many equity indices reported double-digit returns, yield spreads in the high yield bond and leveraged loan markets contracted, and Treasury yields fell across the curve.¹ (See Figure 1.)

While we believe Goldilocks thinking is always dangerous, we think it’s especially so now, as investors are facing an environment in which multiple long- and short-term market tailwinds are weakening and, in certain instances, turning into headwinds that could create new risks and opportunities in the years ahead.