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Strategy shifts ahead of a return to normalcy

| December 4, 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.

The November rally was enough to push the investment grade corporate bond index into positive territory for the year as spreads tightened below last winter’s levels. As markets turn the corner, our updated sector recommendations should guide investors looking to maximize excess return in 2021.

We are making numerous changes reflecting our updated views on the market for the first half of next year, many of which were expressed in our recently published outlook for 2021 (APS Strategy: Corporate Bond Outlook 2021). Most notably, we are moving our views to an overweight on energy, financial companies, and REITs, while moving utility credits to an underweight. We are also taking banks and consumer non-cyclical to market weight from their previous overweight views.

Below we provide 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 we recommend that portfolio managers should position their holdings relative to the broad IG corporate bond market.

Exhibit 1. APS Sector Recommendations for December 2020

Source: Amherst Pierpont, Bloomberg/Barclays US Corp Index

November was pure “risk-on” for the IG Corporate Bond Index, as the aggregate OAS tightened by 27 bp for the month, producing a 2.33% excess return – the best monthly performance since May of this year. Total return was 2.79%, as the long-end of the curve flattened, producing outperformance among longer-dated securities within the Index. The rally was enough to edge the annual performance of the IG Index into positive territory, as spreads remain roughly flat versus year-end, and year-to-date excess return sits at +0.43% as of month-end.

Energy (4.00% excess return) led the charge as oil prices surged roughly 27% from the previous month-end. For the first time in four months, another sector managed to beat out finance companies for the best performance in the Index, but the segment still provided an impressive 3.90% excess return with spreads tightening roughly 70 bp in aggregate. Several developments in COVID-19 vaccines spurred a massive recovery in any credits related to air travel, including the aircraft lessors, which make up a large component of finance companies. The subgroup is among the focus topics in our outlook for 2021 (APS Strategy: Corporate Bond Outlook 2021). Transportation (3.19%), communications (2.93%) and basic industry (2.79%) rounded out the top 5, with the former two demonstrating the market’s preference for longer-duration segments. The weakest returns in November were primarily among financials, with banking (1.39%), broker/asset managers (1.74%) and REITs (1.76%) all underperforming the broader Index. Technology (1.95%) and consumer cyclical (2.00%) rounded out the bottom 5, as investors sought higher beta opportunities elsewhere.

For the first time since July, the IG new issue calendar failed to outpace the monthly results for 2019, as issuance dropped 9% YoY to just over $100 billion for November. Verizon (VZ: Baa1/BBB+) helped narrow that gap with a massive 5-part $12 billion debt launch, earmarked for spectrum purposes and retirement of debt – it represented one of the five largest debt launches of 2020. Still, the YTD total remains roughly 56% above 2019 through the first 11 months of the year, and on record-setting pace to finish over $1.9 trillion. While early debt redemptions and retirements still remain the primary use of proceeds for the IG new issue market, we began to see at least a few instances of corporate management teams pursuing debt-funded share repurchases in November. This trend of increased shareholder enhancement is one we expect to accelerate in the coming year, and a credit consideration we address at length in our Outlook piece referenced above.

Exhibit 2. Supply Recap

Source: Bloomberg LP

Exhibit 3. Energy and finance companies lead the market tighter

Source: Bloomberg Barclays US Corp Index

Exhibit 4. “Down-in-credit” trade remains prominent in November

Source: Bloomberg Barclays US Corp Index

Exhibit 5. Curve flattening favored long-dated maturities

Source: Bloomberg Barclays US Corp Index

Exhibit 6. Aircraft lessors, retail and energy among the month’s top performers

Source: Bloomberg Barclays US Corp Index

IG Corporate Bond Index – Year-to-Date (YTD) Return Attribution Summary

Exhibit 7. Energy remains in negative territory YTD despite recent rally

Source: Bloomberg Barclays US Corp Index

Exhibit 8. Single-A credit still top performer on a YTD basis, BBB gaining ground

Source: Bloomberg Barclays US Corp Index

Exhibit 9. Extraordinary total return in the long-end somewhat offset by lagging excess return YTD

Source: Bloomberg Barclays US Corp Index

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