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Corporate debt is expected to outperform governments given the yield pickup and still supportive credit fundamentals. Near term technicals in investment grade and high yield remain a headwind but spreads should eventually modestly tighten from recent highs. On a 12 month view riskier bonds, including high yield, remain the best but not necessarily good value in the US and EU.
August was another difficult month for most corporate bond markets
In general, August was another difficult month for most corporate bond markets, both investment grade and high yield, with only European corporates outperforming domestic sovereign debt. In the US, Bloomberg data showed the average investment grade yield ending the month 11 basis points higher at just above 4%, its highest for two years. With heavy issuance early in the month, safe haven buying late in the month and increasing outflows from ETFs amidst rising market volatility, it was no surprise spreads widened, albeit fairly modestly by 6 basis points to 181 basis points, again the highest for two years. Resources account for nearly 12% of US investment grade, however, and, ex its losses, returns would have matched those from US treasuries.
US high yield suffered a similar but more extreme fate given the continued collapse in oil and commodity prices and their impact on respective high yield bonds. Bloomberg data had yields close to 7.50% at month end and the spread at 513 basis points, via a recent peak of 563 basis points, and up another 30 basis points over August. It should be noted, however, that energy is still nearly 15% of the Citi High Yield Market Index and in losing nearly 8% over the month, energy accounted for the bulk of the index decline. Indeed, ex energy and basic materials, the high yield index lost 0.9%, according to Citi data.
In the UK BBB spreads jumped 20 basis points over the month, with nearly all the increase occurring during the period of equity market turmoil, generating a monthly loss of 1.2% for investment grade. Not only were redemptions an issue in the UK but were especially so in Europe, with the last week of the month seeing the largest ever from retail funds with an outflow of €1 billion (2% of AVM), according to JP Morgan data. Even with crowded long positions and tight liquidity, EU investment grade and high yield both outperformed domestic sovereign returns, albeit shorter duration helped.
Corporate Bond Outlook
Spreads have widened in most markets in recent months and generally for good reasons. In the US, for example, both investment grade and high yield have suffered losses in energy and metals/mining. IG has also had to contend with heavy issuance and high yield from significant ETF withdrawals. Near term, US investment grade and high yield spreads may well continue to be buffeted by global issues but none are new and lower spreads are expected over time. The US high yield index is to some degree a hostage to fortune to the resource sectors which suggests ongoing volatility but also the prospect of a decent bounce.
UK BBB still appears good relative value at such a wide spread. EU credit should continue to outperform local governments markets, being much earlier in the credit cycle, but relative valuations remain poor.
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