The Long and Short
A tough June sets up perhaps a better July
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.
After modest gains in May, the investment grade corporate bond index headed south again in June, producing the third worst month of excess returns so far this year at -1.78%. Aggregate OAS widened 25 bp and total return for corporate bonds was -2.80% for the month as rates continued to rise. US investment grade bond funds saw nearly $26 billion in outflows in June. Higher beta credit took the hardest hit, and few parts of the Index escaped the punishment to risk assets throughout the month.
We are not making any changes to our sector relative value views this month. The graphic below 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 suggestions serve as a proxy for how we recommend that portfolio managers should position their holdings relative to the broad IG corporate bond market. The relative value recommendations consider a six-month time horizon.
Exhibit 1. APS Sector Recommendations for June 2022
Source: Amherst Pierpont, Bloomberg/Barclays US Corp Index
Color = recommendation: Green – undervalued, Red – overvalued, Yellow – neutral
Size = Market Value within the IG Index
Exhibit 2. Monthly Excess and Total Returns for the IG Index
Source: Amherst Pierpont, Bloomberg/Barclays US Corp Index
The anatomy of this month’s sell-off was not particularly surprising given the broad markets’ collective aversion to risk assets. Higher beta credit suffered the worst of the losses with low-BBB corporate bonds registering a massive -2.46% excess return for the month on 40 bp of aggregate spread widening. Communications (-2.60% excess return) produced the single worst performance by sector, followed by basic industry (-2.54%), finance companies (-2.19%)—which saw a staggering +61 bp in OAS widening for June—energy (-2.11%) and insurance (-1.96%). There were not many places to hide by sector, but those areas that saw greater resistance to the broad sell-off included: utilities (-1.45%), banking (-1.50%), consumer cyclical (-1.58%), technology (-1.60%), and surprisingly REITs (-1.71%). Within the finance companies segment, business development companies (BDCs) continue to serve as among the most sensitive areas of credit; while on the other end of the spectrum, universities and medical centers are among the defensive credits, albeit in limited volume.
Although the League tables for investment grade corporate bond issuance read $136 billion for the month of June, just below last year’s figure, the actual volume for true corporate bond issuance was closer to $70-75 billion, which fell well short of the roughly $90 billion in estimates for the month. Borrowers stood down and delayed their debt issuance needs amidst the heightened global volatility that kept demand for paper at bay. The last three weeks of the month produced just $25 billion in total volume, including a very rare week with zero issuance. Expectations for July remain extremely muted with consensus estimates around $80 billion for the typically, seasonally slow month. A reversal in sentiment could obviously surprise to the upside if some of the issuers that remained on the sidelines in June choose to revisit their postponed deals.
Exhibit 3. Gross and Net Supply Recap
Source: Bloomberg LP, LEAG Tables, new debt and maturity SRCH
Exhibit 4. Annual IG Corporate Debt Issuance (and YTD)
Source: Bloomberg LP, LEAG Tables, new debt and maturity SRCH
Exhibit 5. Weekly Mutual Fund Flows year-to-date
Source: Bloomberg LP, Refinitiv/Lipper weekly flow data
Exhibit 6. New Issue by Sector
Source: Bloomberg LP, LEAG Tables, new debt and maturity SRCH
Exhibit 7. New Issue by Rating
Source: Bloomberg LP, LEAG Tables, new debt and maturity SRCH
Exhibit 8. New Issue by Tenor
Source: Bloomberg LP, LEAG Tables, new debt and maturity SRCH
Exhibit 9. Flight to quality favors communications, consumer, tech, and utilities
Source: Bloomberg Barclays US Corp Index
Exhibit 10. The late month recovery in credit was very much a flight to quality
Source: Bloomberg Barclays US Corp Index
Exhibit 11. Long-dated paper benefits as treasuries rally off the wides
Source: Bloomberg Barclays US Corp Index
Exhibit 12. Once again business development companies (BDC) are among the hardest hit in the washout in credit; universities and medical centers fare best
Source: Bloomberg Barclays US Corp Index
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