1. What’s your overall view of the investment grade (IG) corporate bond market?
The IG corporate bond market is coming off an exceptionally challenging year. Rising interest rates coupled with wider credit spreads resulted in historically weak IG corporate bond market returns of -15.76% in 2022, with an excess return of -1.25% versus US Treasurys.[i] Despite the poor performance, underlying fundamentals were relatively sound during the year. Interest rate coverage metrics were near record levels, revenue growth was strong and corporate leverage largely returned back to pre-COVID-19 levels.
We are cautious heading into 2023 given tight valuations and our expectations for deterioration in corporate and consumer health. The US economic cycle appears to be in the late stage of the expansion and we believe the likelihood of a downturn has increased. We are beginning to see early signs of deterioration in corporate fundamentals. Though our credit research analysts continue to carry a stable or positive outlook for the majority of industries, they have revised a number of industry outlooks to negative. Margin growth has started to stall out across a number of different industries and we anticipate continued margin deceleration as the economy slows. Many company management teams have been accelerating shareholder-friendly financial policies, which is a hallmark of the late expansion phase.
2. What are your expectations for spreads and yields?
IG spreads are currently more than 30 basis points wider than they were at the beginning of 2022 and slightly wide to the 10-year average.[ii] We view these spread levels as relatively tight given the more difficult inflation backdrop and our expectations for weaker domestic and global growth. While we expect IG corporate spreads to widen further this year, low dollar prices and elevated all-in yields could attract money from the sidelines and limit spread widening.
IG corporate yields began 2022 at an all-time historical low (2.32% yield to worst for the Bloomberg US IG Corporate Index as of 31 December 2021). Rising yields and spreads throughout 2022 have brought index yields to levels not seen since before the global financial crisis (5.42% yield to worst for the Bloomberg US Corporate Index as of 30 December 2022). Importantly, higher yields can add to future return potential, but also help provide a cushion against further yield and spread increases.
3. What technical factors are at play in the IG market?
IG market technicals have been fairly positive as we kick off 2023 and the primary market appears healthier with new issue concessions about 50% lower than they were six months ago. The market expects less long-dated corporate issuance (15 to 30-year bonds). This could help long bonds to outperform relative to shorter maturities and flatten the shape of 10s/30s credit curves,[iii] particularly in industrial sectors. Bid-ask spreads in the secondary market have tightened over the past few months, reducing transaction costs for investors. After experiencing outflows for most of 2022, inflows returned to the IG corporate market in January with $6.6 billion added to IG funds in the week ending 11 January 2023.[iv] Overall, given the manageable supply outlook, lower anticipated market volatility and elevated all-in yields, we expect IG market technicals to skew positive in 2023.
[i] Source: Bloomberg. Annual returns as of 31 December 2022.
[ii] Source: Bloomberg, as of 17 January 2023.
[iii] The slope of the credit curve between 10-year and 30-year maturities.
[iv] Source: Bloomberg/Lipper, as of 11 January 2023.
Views as of 23 January 2023.
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