May 24, 2016
Risk appetite was weak in the first six weeks of the year as oil prices tumbled to their lowest levels since 2003, but the primary investment-grade corporate bond market ended the quarter seemingly unfazed by market volatility. Gross new issuance for the first quarter of 2016 totaled $357 billion, $10 billion ahead of last year’s first quarter total. At the current pace, investment-grade corporate bond supply could exceed 2015’s total volume, and potentially set a new record.
Bear markets rarely end in an untested recovery. During the financial crisis, for example, investment-grade corporate bonds issued by the financial sector re-tested lows after what seemed to be a swift recovery at the end of 2008. Investment-grade bonds issued by the energy sector have failed to re-test their lows, which suggests to us that there is more volatility ahead.
Source: Bank of America Merrill Lynch, Guggenheim Investments. Data as of 3.31.2016.
Investment-grade corporate bonds delivered their strongest quarterly performance since the third quarter of 2010, with the Barclays Investment-Grade Corporate Bond index posting a positive 4 percent total return. Despite spreads widening to 215 basis points in mid-February, they ultimately ended the quarter at 163 basis points, 2 basis points tighter compared to the end of 2015, the first such move in spreads since 2012. The biggest moves were in energy and basic materials, which saw average bond spreads tighten by 27 basis points and 70 basis points over the quarter, respectively.
As the chart above shows, the rebound in investment-grade energy bonds is reminiscent of the early rally in financials in December 2008. Investment-grade financial spreads tightened by 102 basis points between Dec. 5, 2008 and Jan. 13, 2009, but following this temporary rally, spreads widened again by 208 basis points to set a new historical peak before markets settled for the remainder of the year. History has taught us that bear markets do not end quietly. The opportunity to pick up bonds at more attractive levels is likely to emerge in the upcoming months as volatility returns. However, given our macroeconomic team’s view that oil should average $40–$45 per barrel for the remainder of 2016, we will use market weakness to proactively seek energy names that are likely to survive oil prices below $60 per barrel in 2016 and 2017. Yields of 4.5 percent in the energy sector look attractive compared to average yields of only 3.25 percent for the broader market. When evaluating credits in other sectors offering low-3 percent yields, we also prefer to wait for the opportunity to buy them over the summer, which tends to be a seasonally weak period for risk assets.
As of March 31, 2016, investmentgrade corporate bond yields were only 3.25 percent, on average— their lowest yield since June 2015. Yields of 4.5 percent in the energy sector look relatively attractive. While these yields compensate for historical credit loss rates, we believe there will be the opportunity to pick up bonds at more attractive yields in the upcoming months as we enter a seasonally weak period.
—Jeffrey Carefoot, CFA, Managing Director; Justin Takata, 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.
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