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IG index performance and outlook

| September 6, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Below is a summary of how the sectors within the investment grade (IG) index are expected to perform for the next several months, on an excess return basis (total return net of commensurate US Treasury return). These serve as a proxy for how portfolio managers should position their holdings relative to the broad IG corporate bond market. Better performance is anticipated from lower-rated segments with greater risk compensation (OAS), as global investors will continue to move out the credit spectrum in the search for higher yields in US dollar spread product.

Exhibit 1. Sector recommendations for remainder of 2019

Source: Bloomberg Barclays US corporate index, Amherst Pierpont Securities

The month of August started with a rapid back-up in credit, as Treasuries rallied and the stock market faltered amidst trade war drama and increased calls for a recession on the near-term horizon. Corporate spreads eventually recovered some, but the IG corporate bond index closed the month with OAS net +12 bp wider, generating a negative -1.13% excess return for August (and +3.14% total return with the rally in UST). Financials led the overall performance for the month, with REITs (-0.30% excess return), banks (-0.44%) and broker/asset managers (-0.55%) all finishing in the top 5, proving most resistant to the early sell-off in credit. Tech (-0.91%) also rounded out the top performers, bolstered by strength in semiconductors and communications equipment, and individual gains in unique credit situations, such as VRSK and MRVL. The energy trade continued to sell-off for a second consecutive month, representing the worst performing sector in the index (-2.06%), joined at the bottom of monthly performers by basic materials (-1.72%), transports (-1.71%) and financial companies (-1.51%) – due almost entirely to the release of the whistle-blower report and related sell-off in General Electric (GE). For the first time in a while, lower-rated credit (BBB -1.28%) failed to outperform its higher-rated counterparts (AA -0.77%, A -1.00%) within the index.

Exhibit 2: Spread-to-yield ratio – remains almost a full standard deviation above the mean; indicating spreads have room to tighten and investors may target lower-rated credit

Note: The ratio tends to move in a negative relationship with nominal corporate bond yields. If UST rates were to turn negative, it could make this ratio irrelevant. Source: Bloomberg Barclays US corporate index, Amherst Pierpont Securities

USD IG supply dipped -4% year-over-year in August, after last month’s tremendous +45% gain over the prior year. The month brought $84 billion in new IG supply, plus an additional $14 billion in high yield, which was down -21% from August 2018. The jumbo print in OXY/APC of $11 billion in M&A financing and XOM’s $7 billion multi-tranche launch helped bolster the overall total in IG. August’s IG supply was the lowest level since a very quiet 2015 ($52 billion). The first week of September brought a flurry of anticipated activity. Perhaps a surprising amount came in the EUR-denominated corporate market, despite the collapse of long-end rates in UST over the past several weeks. Most notably, Danaher brought a five-part €6.25 billion deal to help finance its purchase of GE’s bio-pharma business, which is a credit positive for GE as it indicates execution on the deal is progressing as planned. The all-cash total deal size is over $20 billion, so there will likely be a USD launch as well. It’s a small sample set obviously, but just judging from the activity to kick off September new issue season, issuers seem to be tapping both the USD and EUR markets with similar enthusiasm.

Exhibit 3: August supply recap

Source: Bloomberg, Amherst Pierpont Securities

According to Bloomberg, estimates have September’s anticipated seasonal burst of activity in the $110-125 billion range, which is more likely to come at the lower end of that range. The past three years’ September totals for IG were elevated at $150 billion, $141 billion and $153 billion respectively, and were partly aided by jumbo deals by Cigna in 2018 and Takeda in 2016. Despite low rates and the strong global appetite for USD spread product, original expectations were that activity this month could be bit more subdued, given the limited backlog of notable M&A deals that still need funding following the OXY/APC launch in August and DHR tapping the EUR market first. In addition, the bigger serial issuers (i.e. money center banks) had typically been addressing their maturity schedules earlier in the calendar year.

So far that has not been the case, unless this indicates a tremendously front-loaded month in progress. Late summer saw a fresh round of “opportunistic” tender-and-issue activity, which is already evident in September with Disney’s tender-and-issue 6-part offering to take out high coupon legacy paper in its own cap structure and  21st Century Fox (other tender/issues from UNM, APH, BBVA as well). DIS’s debt launch was part of a record-breaking 21 issuers and staggering $21 billion in volume on the first day of the month. That was followed by 14 separate issuers tapping the IG market on Wednesday, bringing the month-to-date total over $50 billion in just two days. Thursday brought another full slate of issuers as well, bringing the MTD total to a record over $70 billion. Apple (AAPL) brought its first debt issue since 2017, a five-part $7 billion launch that matched their last trip to the public debt market. The rest of the haul so far has been highly diverse, including high-quality bellwethers (KO, AAPL, DIS), more REITS (SPG, HIW, ACC, HTA), more utilities (EXC, SO, XEL, PPL), more energy/pipes (PSXP, ENBL, MPLX), banks (C, JPM, WFC, CS, COF, KEY), and a mix of other industries.

Exhibit 4: August 2019 – Index performance by sector

Source: Bloomberg Barclays US corporate index, Amherst Pierpont Securities

Exhibit 5: August 2019 – Index performance by rating

Source: Bloomberg Barclays US corporate index, Amherst Pierpont Securities

Exhibit 6: August 2019 – Index performance by maturity

Source: Bloomberg Barclays corporate index, Amherst Pierpont Securities

Exhibit 7: Historic spreads – Index OAS and A vs BBB credit; lower-rated credit finally under-performed amidst the August back-up in credit

Source: Bloomberg Barclays US corporate index, Amherst Pierpont Securities

IG corporate bond index – year-to-date 2019 return attribution summary

Exhibit 8: Year-to-date – Index performance by sector

Source: Bloomberg Barclays US corporate index, Amherst Pierpont Securities

Exhibit 9: Year-to-date – Index performance by rating

Source: Bloomberg Barclays US corporate index, Amherst Pierpont Securities

Exhibit 10: Year-to-date – Index performance by maturity

Source: Bloomberg Barclays US corporate index, Amherst Pierpont Securities

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