August 23, 2018
Foreign buyers, predominantly out of Asia, have reduced the pace and size of U.S. corporate credit purchases. At the same time, Treasury yield curve flattening and rate volatility due to quantitative tightening have stymied the participation of domestic insurance companies, which otherwise would have made up for the shortfall in foreign demand. This is likely to exacerbate the existing steepening in the 10s/30s corporate credit curve, which was at year-to-date wides of 45 basis points at the end of the first half of 2018. Net issuance, down 25 percent year to date, has been a positive technical factor, but will reverse in the second half of 2018 as redemptions were front loaded in the first half of the year.
Spreads widening to levels not seen since December 2016, a backup in rates, and a steady flow of BBB mergers and acquisitions (M&A) financing contributed to investment-grade corporate bonds returning -2.75 percent through the first half of 2018, dramatically underperforming high-yield bonds and equities. Weaker demand from foreign buyers and increasing headwinds, mainly due to looming trade wars, will likely precipitate heightened volatility and limit spread performance in the third quarter.
BBB-rated bonds now account for around half of the investment-grade corporate bond universe, up from 30–35 percent 10 years ago. This trend has been driven by a slew of large M&A deals, such as the AT&T/Time Warner merger, which have successfully gained regulatory approval. Notwithstanding strong market fundamentals, the glut of BBB corporates is cause for concern as they are increasing leverage in a rising rate environment (see chart, bottom right). In the short term, we expect to see pockets of buying from domestic insurers and pension funds. With trade wars intensifying and an extended credit cycle, however, investment-grade corporate spreads remain vulnerable. To that end, we continue to prefer higher-quality corporates with lower spread beta. We believe this will work in our favor when lower-quality credits are exposed at the turn of the credit cycle and credit spreads widen. The rise of passive investors in the investment-grade space also exposes the market to forced selling in the event these bonds get downgraded to below investment grade, a problem that would only be exacerbated by poor liquidity conditions as investors head for the exit.
BBB-rated bonds now account for around half of the investment-grade corporate bond universe, up from 30–35 percent 10 years ago. This negative rating migration introduces a greater risk of downgrades from investment grade into high yield when the credit cycle turns.
Source: Bloomberg Barclays, Guggenheim Investments. Data as of 4.30.2018.
The market value of investment-grade debt with leverage greater than the BB average (which currently stands at about 3.9x) is now greater than BB-rated debt outstanding in the Barclays High-Yield Index. At the turn of the credit cycle, potential downgrades into high yield could create liquidity disruptions as the high-yield market absorbs new entrants. This would affect investment-grade and high-yield investors alike.
Source: Bloomberg Barclays, Guggenheim Investments. Data as of 3.31.2018.
—Jeffrey Carefoot, CFA, Senior Managing Director; Justin Takata, Managing Director
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2018, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.
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