The “January effect” was in full swing across credit markets in the first quarter, as investor thirst for yield, improving fundamentals, and supportive technical factors drove continued spread compression across many areas.
In corporate credit, the U.S. leveraged loan and high yield indices returned 1.9% and 1.4%, respectively, while the loan and high yield default rates ended the quarter at 3.9% and 5.4%, respectively. First quarter U.S. high yield default volume was $3.4 billion—the lowest it has been since $2.3 billion defaulted in the third quarter of 2018—and further downward pressure on the default rate is expected over the months ahead. Meanwhile, S&P Global Economics raised its real U.S. GDP growth forecast for 2021 and reported falling leverage and increasing interest coverage for borrowers. Improving fundamentals coincided with outperformance in the lowest-rated cohort in the high yield index, with the CCC bucket strongly outperforming the B and BB cohorts during the quarter.
In the structured credit market, the search for yield and improving fundamentals drove spreads lower. The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index rose to over 11% in January, after increasing more than 10% annually in 2020. Despite some softening at quarter-end, assets with longer duration or more credit risk generally outperformed, and only select sectors—like aircraft ABS—continued to trade wide of pre-pandemic levels. Spread compression was also seen in the CMBS market, where the relatively wider spreads attracted investors seeking yield pickup. The continued rollout of COVID-19 vaccines and improved delinquency numbers, in addition to light issuance, provided support to CMBS bonds.
Reflecting a continuation of 2020’s robust primary market activity, the convertible bond market saw $58.3 billion of new issuance globally in the first quarter, with the issuer cohort being dominated by technology companies seeking to opportunistically boost balance sheet liquidity. The SPAC market saw record IPO volume in January and February, and investors adjusting their exposure to make room for new issues led to premium compression and presented opportunities to capture attractive names trading on positive yields.
M&A momentum continued into 2021, as U.S. volume increased 100% year-over-year, reaching an all-time first quarter high. As of the end of the quarter, the HFRX Merger Arbitrage Index posted a 2.3% gain, aggregate deal value stood at $420 billion, the average annualized spread stood at 13%, and the total arbitrage profit pool stood at $22 billion. Looking ahead, we believe the stage is set for a robust year of M&A.
Turning to global real estate, the market has seen a modest increase in activity as the global economy has started to show signs of recovery, albeit varied by region. Although uncertainty remains in the marketplace, fiscal support coupled with accommodative lending practices has suppressed what was feared to be a period of widespread distress across real estate. Globally, industrial and multifamily properties have continued to demonstrate strong fundamentals, while most hospitality and retail assets remain challenged. Office continues to face uncertainty, and secular headwinds have weighed on fundamentals as users reconsider their space usage in light of hybrid work models.
Financial market exuberance surrounding the reopening of the economy may mask the lasting secular impacts on certain property types and geographies. However, the combination of low absolute yields, moderately elevated inflation, and significant dry powder is broadly supportive of real estate values. We believe that elevated operating headwinds across property types and geographies should create more investment opportunities.
In the U.S., the rapid response of the Fed and Congress largely restored liquidity in the market, and consumer sentiment has continued to improve, with household savings and disposable income at record highs. Transaction volumes continued to increase month-over-month, but still declined 28% year-over-year in the first quarter. Although loan delinquency rates have improved, there has been increased activity in recapitalizations and forced sales as borrowers seek solutions to perceived long-dated recoveries for certain investments. With regard to valuations, the Green Street Commercial Property Price Index increased 2.6% quarter-over-quarter in the first quarter, but with significant variation by property type.
In Europe, another series of lockdowns has continued to put pressure on economies across the region. Current estimates indicate that GDP growth will be muted across the eurozone in the first and second quarters of 2021. The economic strain has limited both real estate transaction volume and leasing activity in Europe, though fundamentals and transaction volumes for industrial properties have demonstrated resilience. Retail properties continue to be challenged, with annual net store closures reaching a record high in 2020.
Asian economies have led the global recovery, with strong economic growth exhibited in Japan, South Korea, and China. Notably, office fundamentals have demonstrated relative stability in certain Asian markets; cap rates for prime South Korean office assets have compressed to historical lows, while rents and occupancy levels have remained stable in Japan. The logistics sector remains an outperformer across the region, with the growth of the e-commerce industry driving leasing and investment momentum.