The Long and Short
Wider spreads contribute to worst total returns since 2008
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. This material does not constitute research.
Investment grade corporate bonds delivered a negative 2.00% total return for the month of February, as the combination of Ukraine related concerns and pre-Fed Treasury selling capped off the worst two-month span for the index since the heights of the financial crisis. Net OAS spreads widened by 14 bp resulting in a negative 1.16% excess return for the month. The index topped out at +124, the widest level since November of 2020.
For the month of March, we are making two changes to our sector weighting views. We are changing the outlook on the insurance sector to Marketweight from Overweight and changing the outlook on technology to Overweight from Marketweight. The changes reflect the difficult environment for credit, and investors’ increasing sensitivity to long duration sectors ahead of the Fed. The two graphics below 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 and 2. APS Sector Recommendations for March 2022
Source: Amherst Pierpont, Bloomberg/Barclays US Corp Index
Color = recommendation: Green – Overweight, Red – Underweight, Yellow – Marketweight
Size = Market Value within the IG Index
Source: Amherst Pierpont, Bloomberg/Barclays US Corp Index
Investors sought out relative safe havens within the IG corporate index amidst the sell-off in credit. The top 5 performances by sector were technology (-0.71% excess return), banking (-0.85%), consumer cyclical (-0.99%), REITs (-1.01%) and finance companies (-1.01%) – although the latter exhibited the single worst performance by sector on a spread basis (+23 bp). Finance companies’ spreads widened relative to the overall market as investors demonstrated trepidation in aircraft leasing credits that have direct exposure to the Russian airlines, and business development companies (BDCs) took a hit on lending concerns with the move in rates. The worst performances by sector included natural gas (-2.09%) and utilities (-1.76%), as well as basic industry (-1.47%), communications (-1.45%), and insurance (-1.37%). It was a difficult month to identify consistent trends among segments, other than a pure risk-off posture for the broader market with BBBs underperforming and AAA/AA credit leading the index.
The IG primary calendar came in fits and starts as issuers in February attempted to navigate the difficult day-to-day and week-to-week swings in sentiment. In the end, borrowers managed to place just under $84 billion in debt deals throughout the month, coming in at the lower end of the range of estimates. While it was a significant year-over-year drop from February ’21, the persistence of the IG calendar was worth noting. In particular, quite a few deals launched in conjunction with tender offers, as management teams were/are still trying to term out maturities and manage down interest expenses ahead of the Fed. High yield added just $9 billion in issuance for the month as the market froze up in the second half of the month amidst geopolitical concerns and broad credit selling. The market is expecting $125 to 150 billion in IG issuance for March, which may be a high hurdle with the distractions of the FOMC and ongoing conflict abroad.
Exhibit 3. Supply Recap
Source: Bloomberg LP
Exhibit 4. Once again, the sell-off in credit felt universally across the index, more defensive segments provide some insulation
Source: Bloomberg Barclays US Corp Index
Exhibit 5. Flight to quality amidst the February sell-off in credit
Source: Bloomberg Barclays US Corp Index
Exhibit 6. Long duration paper hardest hit in the February sell-off
Source: Bloomberg Barclays US Corp Index
Exhibit 7. Small regional banks feature prominently among top performers by ticker, while business development companies notable among the mixed bag of bottom performers
Source: Bloomberg Barclays US Corp Index
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