Since the downturn of global financial markets on August 5—a so-called Black Monday given the significant losses across major stock indices—investors have become more risk averse. The purpose of this article is to help investors sail through the uncertainty in the second half of 2024. We will discuss the causes of the market instability and shed light on corporate credit risk profiles at regional, country, industry, and entity levels.
Corporate risk profiles across different regions present a mixed picture.
According to our Criat Credit Cycle Index (CCCI), which measures the aggregate credit risk of an economy/sector by taking the median one-year probability of default (PD) across all publicly traded firms in their respective group, the outlook is more optimistic for APAC and EMEA regions compared to the North America (NAMER) and Latin America (LATAM) regions.
As shown in the following chart, Canada, Argentina, and China face elevated risk conditions among their G20 peers. Their CCCI, when translated to a probability of default implied rating (PDiR), stand at BB as of August 12. That indicates concerns over their financial stability and potential vulnerability to economic downturns or external shocks.
Despite a better-than-expected recovery that was driven by exports in the second quarter of 2024, the Chinese economy still faces pressure to stimulate domestic activities and stabilize growth in the aftermath of its real estate crisis.
Argentina faces severe economic challenges, including high levels of debt, inflation, and insufficient foreign exchange reserves. Additionally, political instability and frequent changes in economic policies have also contributed to Argentina's elevated risk profile in its corporate sector, making it difficult for businesses and investors to plan for the future.
Corporates in Canada are struggling with a stagnating economy and high interest rates, but the worst may be behind the sector.
Japan and the U.S., the combined epicenter of the Black Monday, exhibit divergent trends in their credit risk outlook. Despite market jitters, Japan has its PDiR firmly held at BBB+, underscoring the resilience of its financial institutions and solid financial standing of the corporate sector.
Conversely, the U.S. finds itself in a position of heightened risk, with a cloudy economic outlook after two years of a tightening cycle. Uncertainties surrounding U.S. domestic policies and trade relations cast a shadow over the country’s economic trajectory, necessitating a cautious approach as corporates navigate a transition period.
The August 5 market downturn was a perfect storm triggered by Japan’s policy pivot and the recession fear clouding the U.S. economy. After two decades of near-zero or negative interest rates, the Bank of Japan announced a plan on July 31 to reduce government bond purchase and increase the key interest rate to about 0.25% from a range of 0 to 0.1%.
That decision sent shockwaves through the foreign exchange market and put pressure on the Japanese stock market. It also led to rapid appreciation of the yen against the U.S. dollar, increasing by more than 4 yen in a single day. On August 5, the USD/JPY pair saw a significant intra-day plunge of nearly 3%, approaching the 140 level.
Furthermore, discouraging U.S. employment statistics intensified market skepticism. Figures that the Bureau of Labor Statistics disclosed on August 2 indicated an increase of 114,000 nonfarm payroll for July, falling short of the 175,000 additions anticipated by economists. Concurrently, the unemployment rate climbed to 4.3%, an increase from the 4.1% recorded in June, reaching its highest mark in the last three years.
A deteriorating risk outlook usually translates to poor capital market performance. However, the opposite may not always be true. Our regional, industry, and entity level credit health assessments demonstrate that market fluctuations—especially short-term ones—are sometimes driven by overreactive investors and do not necessarily imply worsening credit profiles.
In the next chart, we look at the impacts of the market turbulence on credit risk across major economies and across industries in Japan.
Globally there was an 8.6% increase in credit risk.
APAC saw the most notable increase in PD, experiencing a 10% increase.
EMEA followed closely behind with an 8.1% increase.
NAMER experienced a 5.2% increase.
LATAM had a relatively low increase of 4.4%.
We also noticed that, on August 5, the stock markets of Japan and South Korea led the world in declines, dropping by 12.40% and 8.77%, respectively. Interestingly, South Korea’s PD witnessed a remarkable surge, increasing by 30.5% to 17.14 bps. Although Japan’s PD also rose significantly by 13.9%, its PD remained low at 4.47 bps.
Despite causing market panic, the substantial volatility in the Japanese stock market has not impacted Japan’s overall risk level as severely as expected. The risk outlook for Japan remains relatively healthy.
Further analysis of risk-level changes on August 5 across various sectors in Japan showed:
The Financial sector’s PD single-day increase reached a staggering 25.0%, with the current 1-year PD at 12.83 bps.
The Technology sector’s PD increase was the second highest at 23.5%, with the current 1-year PD at 4.02 bps.
The Consumer Staples and Utilities sectors appeared unaffected by the dramatic shake-up in the Japanese stock market.
Clearly, the Japan financial sector was hit the hardest. The stock price of Mitsubishi UFJ Financial Group (MUFG), one of the most affected banks in Japan, plunged by 21%, setting a new intraday record. Its PD also soared to a new high since the pandemic.
However, MUFG’s current PD of 14.40 bps is far below the historical peak at 207.58 bps during the 2008 financial crisis, demonstrating strong resilience. Additionally, MUFG maintains a stable financial structure and asset quality, with robust capital adequacy and liquidity. Furthermore, MUFG holds a solid position in the global market as it diversifies its business, therefore effectively mitigating risks associated with a single market or business area. Considering these factors, the risk outlook of MUFG is considered healthy and resilient.
Following the sharp decline on Black Monday, Bank of Japan Deputy Governor Shinichi Uchida took steps to stabilize investor sentiment. He addressed the recent volatility in the Japanese market in a speech on August 7, emphasizing that no further hikes will be implemented while markets are volatile. As a result, the Asian markets saw a strong rebound, with the Nikkei 225 index fully recovering the loss on Black Monday.
Given the ongoing market volatility, the reversal of the yen arbitrage trade remains incomplete. However, market attention is beginning to shift toward concerns about a potential U.S. recession. Federal Reserve Chairman Powell stated at Jackson Hole's annual economic symposium on August 23 that a rate cut in September might be appropriate. However, the pace remains unclear. High interest rates are still expected to sustain high borrowing costs for a considerable period, potentially continuing to dampen U.S. economic growth. Additionally, geopolitical tensions from the Palestinian-Israeli conflict and the Russia-Ukraine conflict also influence the market.
It is evident the global financial market remains volatile and uncertain. At a regional level:
The U.S. Federal Reserve has to walk a fine line to prevent resurgence in inflation while avoiding recession, especially given the elevated credit risk in the corporate sector.
While Japan also faces a bumpy road ahead for its policy normalization, the healthy outlook in corporate credit risk should provide some relief.
Overall, the APAC and EMEA regions present a brighter outlook for the second half of 2024 compared to the NAMER region.
Wang Wenyi, Dr Zhu Yanqi, and Zhang Yuanhao also contributed to this article.
Following are definitions of the Criat data mentioned in this article.
Probability of Default (Criat PD): Quantifies a firm’s credit worthiness, i.e., the likelihood that a firm will default on its obligations over different time horizons.
Credit Cycle Index (Criat CCI): Depicts recurring stages of easy and tight credit environment of a sector or an economy via a bottom-up approach of Criat PD movements.
PD implied Ratings (Criat PDiR): Translates Criat PD to letter-grade equivalent to the Big 3 credit rating agencies.
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