The Long and Short
A likely step back after a strong November in IG
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.
Investment grade credit rallied sharply in November in conjunction with the broader global recovery in risk assets, resulting in the strongest monthly performance of the index since 2008. Investment grade bond spreads are now at their tightest level since February 2022, having traded well through the 2023 tights touched prior to the regional bank crisis. However, the market could pause then be poised for a correction after month-end pressures subside, as a large portion of the late-month momentum seems to have been driven by algorithmic trading.
The Bloomberg Barclays investment grade credit index produced a single-month excess return over US Treasury debt of 1.75% in November. When considering the congruent rally in rates that took place throughout the month, the total return was 6.32%—the highest single monthly performance since 2008 – tightening from 129 bp to 107 bp with sentiment currently still strong.
The iShares iBoxx $ Investment Grade Corp Bond ETF (LQD) appears to be trading through the commensurate move in IG spreads (Exhibit 1), pushing more liquid securities through typical resistance levels. As a result, relative value within the secondary market became tougher and tougher to justify as the monthly rally pressed on. There are extreme technicals to the short side of the market, making it difficult for individual institutional investors to express their true perception of market risk. For these reasons, it seems plausible that the market will take a pause to reassess in the final month of 2023, with IG spreads likely to back-up modestly as market pressures cool off.
Exhibit 1. iShares iBoxx $ Investment Grade Corp Bond ETF vs Bloomberg Barclays cash bond Corporate Index (OAS)
Source: Santander US Capital Markets LLC, Bloomberg/Barclays IG Index, iShares iBoxx $ Investment Grade Corporate Bond ETF
Taking a closer look at index sector attribution performance throughout November, investors (and more likely algorithmic trading pressures) favored longer-duration segments of the market, as 30-year US treasuries rallied approximately 60 bp throughout the month. Top performers included long-duration sectors like communications – which likely saw an added boost on better than expected performance from index bellwether VZ – technology, insurance and consumer. Financials mostly lagged the overall index performance, though spreads still moved tighter in those segments.
Exhibit 2. Bloomberg/Barclays cash bond corporate index – Nov performance by sector (excess return over UST as of 11/29/23)
Source: Santander US Capital Markets LLC, Bloomberg/Barclays IG Index
When looking at the ratings spectrum of performance in November, by and large lower-rated credits outperformed throughout the month. Once again, this trend was likely a large byproduct of program trading within a market that appeared to outpace actual institutional investor sentiment. On a day-to-day basis later in the month, the market continued to see relative valuation on off-the-run securities’ spreads compress at a greater clip than the broader market on indication, though highly liquid securities and recent new issues were the instrument of execution that program trading appeared to use to pressure the broader market tighter. Exhibit 3 below demonstrates a fairly straightforward risk-on trend within IG credit throughout the month of November.
Exhibit 3. Bloomberg/Barclays cash bond corporate index – Nov performance by rating category (excess return over UST as of 11/29/23)
Source: Santander US Capital Markets LLC, Bloomberg/Barclays IG Index
In late October, the IG corporate bond indices were flashing an indication that ‘A’ credit appeared poised to outperform relative to ‘AA.’ At the time, ‘A’ credit was trading nearly two standard deviations above the mean relative to ‘AA’ credit on a five-year basis. The relationship was short-lived as broad credit markets, alongside rates, abruptly rallied at one of the sharpest paces in recent history. Still, the relationship holds up as an attractive opportunity for investors on an historic basis, and perhaps an appropriate place for investors to allocate resources with lower-rated credit potentially taking a pause in the weeks ahead. ‘A’ credit is still offering a +46 bp pick to commensurate ‘AA’ credit versus a late October peak of +54 and a five-year average of just under 30.
Exhibit 4. Spread between Bloomberg/Barclays ‘AA’ corporate index and ‘A’ corporate index
Source: Santander US Capital Markets LLC, Bloomberg/Barclays IG Sub-Indices by ratings
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