Investment Grade Corporate Credit Spreads Flashing Yellow

Mark Heppenstall

By Mark Heppenstall | July 5, 2018

This week’s chart highlights credit spreads for investment-grade (IG) and high-yield (HY) corporate bonds since the end of the financial crisis. Wider credit spreads are a sign of tightening liquidity conditions and often provide an early warning indicator for periods of weak equity market performance. As the long-running economic expansion and equity bull market approach record territory, investors should monitor credit spreads to help navigate the changing landscape.

Even though both investment-grade and high-yield spreads are wider since reaching post-crisis tight levels in January, spreads for IG credits have been materially weaker. A few factors help explain the relative weakness:

 

1. Mergers & Acquisition (M&A) activity for IG credits: M&A volume during Q1 2018 was up 50% versus Q1 2017. CVS alone brought a near-record size $40 billion bond sale in March to fund its purchase of Aetna.

2. Duration differential: The duration of the IG corporate market continues to extend and is now nearly twice as long as the duration of the HY market. As the credit cycle extends and the yield curve flattens, investors are increasingly focused on short duration investment opportunities.

3. New supply: Net new issuance for IG bonds remains robust — above $600 billion annually since 2015 — while net HY issuance was negative during the same period. The BBB-rating category is where much of the new IG issuance (including M&A driven deals) is concentrated.

4. Benign default environment: U.S. speculative-grade defaults remain low by historical measures. Moody’s expects the environment to remain favorable “with both unemployment and high-yield spreads at low levels.”*

 

Key Takeaway

Fixed income markets are increasingly displaying signs of caution for financial market performance and global economic growth. The dramatic flattening of the Treasury yield curve has been in the spotlight this year, but credit spread widening trends also merit focus. If valuations for IG and HY credit continue to weaken, flashing yellow will soon turn to flashing red.

 

*Moody’s: Global speculative-grade default Rates down again in May; June 11, 2018

 



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The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.

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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.

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