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Remain defensive; stay overweight less cyclical sectors

| June 5, 2020

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.

Investors should remain in a more defensive posture given concerns about the longer-term global economic fallout of the COVID-19 outbreak and related earnings volatility, with the prospect for recurring spikes in volatility over the near-to-intermediate term. The compounded stress on energy/commodity markets is making it extremely difficult to time fluctuations in valuation among commodity credits, which further supports a call to overweight more defensive segments within the Index. With the re-pricing of credit risk year-to-date, the long-term valuation proposition in higher-rated, less cyclical credits and sectors is compelling enough to forego more aggressive strategies that remain susceptible to shorter-term swings in volatility.

There are no changes to sector recommendations this month. Credit moved pretty much in one direction in May, as the IG Index tightened nearly -30 bp, generating Excess Return of +2.34%, which offset the back-up in Treasuries as Index Total Return finished at +1.56%.

For the second consecutive month, Energy (+7.03 % excess return) provided the highest returns in IG credit, as oil prices continued to recover,  with spreads tightening -88 bp in aggregate for the month. The outsized performance in Energy left little room for other segments to shine relative to the Index. Rounding out the top 3 performers were Basic Industry (+3.27%) and Consumer Cyclical (+2.90%), with the rest of the Index either meeting or falling below the Index average.

Exhibit 1. APS Sector Recommendations for June 2020

Note: The table provides a summary of how APS expects sectors within the IG Index to perform for the next several months, on an Excess Return basis (total return net of commensurate UST return). These weightings serve as a proxy for how portfolio managers should position their holdings relative to the broad IG corporate bond market. Source: Bloomberg/Barclays US Corp Index, Amherst Pierpont Securities

Credit moved pretty much in one direction in May, as the IG Index tightened nearly -30 bp, generating Excess Return of +2.34%, which offset the back-up in Treasuries as Index Total Return finished at +1.56%.

For the second consecutive month, Energy (+7.03 % excess return) provided the highest returns in IG credit, as oil prices continued to recover,  with spreads tightening -88 bp in aggregate for the month. The outsized performance in Energy left little room for other segments to shine relative to the Index. Rounding out the top 3 performers were Basic Industry (+3.27%) and Consumer Cyclical (+2.90%), with the rest of the Index either meeting or falling below the Index average.

Once again, the bottom performances included Finance Companies (-0.23%) and REITs (+1.35%). GE and aircraft lessors remain some of the most stubborn credits to recover in the IG sell-off. Worth noting, however, was AerCap Holdings’ (AER: Baa3*-/BBB/BBB-) successful debt launch this week. AER is highlighted in Exhibit 10 below among the 25 worst performing issuers in the IG Index YTD with +515 bp in aggregate widening as of month-end. The aircraft lessor was placed on review for downgrade by Moody’s this week, along with most other industry peers, threatening its IG status. Nevertheless, AER was able to launch $1.25 billion in 5-year notes at a coupon of 6.75% (down from initial price talk of 8.25%) – an impressive feat emphasizing the market’s renewed appetite for credit risk this week. We believe aircraft leasing companies with the strongest balance sheets and lease portfolio—specifically AER and peer Air Lease (AL: BBB/BBB)—are worthy of focus for investors with higher risk appetites, capable of playing the longer-term recovery. REITs have also been slow to recover as investors maintain their concerns about the longer-term implications for commercial real estate in several of the industry’s subsectors, such as Retail and Office. Utilities (+0.87%) and Banking (+1.70%) were also among the weaker performances in the Index, as investors sought higher yielding opportunities and favored the additional spread available in cyclical, higher-beta segments of the market.

The new issue calendar remained the the most noteworthy story in IG credit, as issuers brought nearly $270 bn in new supply, at a pace of roughly 1.5x the amount seen in 2019 (3 consecutive months of >$250 bn volume). That brought the YTD total north of $1 trillion – roughly twice the volume for the first five months of 2019 and on record pace to surpass any prior year of IG issuance.  The Fed’s announcement of the corporate credit facilities (both primary and secondary) in late March continues to backstop a nearly endless stream of funding opportunities for corporate management teams, who are seeking to term out upcoming loans or debt maturities and/or reduce interest expenses with historically low yields available. The month included only two jumbo launches (AT&T and Disney). High Yield added another nearly $40 billion in issuance to the total, and now stands at >20% of prior year volume despite several months of anemic activity to start the year.

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