The Long and Short
Performance so far this year still favors financials
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.
Performance in investment grade corporates has trailed some key parts of the broad US fixed income market so far this year. This is partially due to spread compression that closed out 2023 as well as the relatively longer duration of the corporate sector. Within that context, the financial sectors have largely outperformed within investment grade corporates, as spread percentile rankings had been indicating at the start of the 2024. Despite this strong performance, financials still hold the most capacity for spread compression for the remainder of the year based on ranking current spreads compared to their distribution over the last five years.
Investment grade corporate debt has trailed the performance of emerging markets, high yield and CMBS while finishing ahead of ABS and MBS (Exhibit 1). The investment grade corporate index came in fourth place with an excess return of 1.00% behind EM USD sovereigns (2.86%), high yield (2.36%) and CMBS (1.81%). Total return of 1.88% came in second to last, as IG maintains the highest duration (6.91) of any of the broad asset classes in the study. Also worth noting, is that this very basic re-cap fails to capture the variability of returns throughout the year.
Exhibit 1. YTD excess and total returns by broad fixed income asset class
Source: Santander US Capital Markets LLC, Bloomberg/Barclays Banking Indices, index duration in parentheses
In exhibit 2 below, each broad fixed income segment is listed by their current five-year spread percentile ranks, with current OAS for each demonstrated as well. Not surprisingly, the better performing segments YTD appear to be the “richer” with regard to where OAS currently ranks along their respective five-year trading histories. With the IG corporate bond index OAS currently around +93 and five-year percentile rank at 25%, it does appear that capacity for material spread compression is somewhat limited, with the asset class poised as more of a carry trade opportunity for the remainder of the year, particularly relative to some of the various classes of structured products.
Exhibit 2. 5-year spread percentile ranks and OAS by broad asset class
Source: Santander US Capital Markets LLC, Bloomberg/Barclays Banking Indices
Exhibit 3 below drills down a layer deeper into the performance of the sub-categories of each asset class for 2024 YTD, with the same metrics of excess and total return demonstrated on the chart. EM LATAM (4.73%), HY financial (3.09%), and non-agency CMBS (2.72%) delivered the three highest performances of the year by credit return, while fixed rate MBS (0.18%), credit card ABS (0.48%) and ABS other (0.57%) delivered the worst, in what was a largely a continuation of the patterns from 2023. IG financials (1.54%) were the best performing corporate sub-category for the year so far.
Exhibit 3. 2024 YTD excess and total returns by fixed income asset class sub-categories
Source: Santander US Capital Markets LLC, Bloomberg/Barclays Banking Indices, index duration in parentheses
Exhibit 4 demonstrates the five-year spread percentile rankings of these same sub-categories as the new year begins. The top six positioned of the market are also all among the segments of structured products that largely underperformed YTD and throughout much of the previous year. Meanwhile, the absolute lowest score recorded in the study is among EM Asia and utility HY, which suggest extremely limited capacity for spread tightening for the remainder of the year. Despite outperformance in the first half of the year, IG financials still appears best positioned among IG corporates.
Exhibit 4. 5-year spread percentile ranks and OAS by sub-category
Source: Santander US Capital Markets LLC, Bloomberg/Barclays Banking Indices
Shifting focus specifically to the IG corporate sector, exhibit 5 demonstrates excess and total returns by individual sector for YTD 2024. The top five performers included finance companies (2.04%), banking (1.72%), REITs (1.57%), energy (1.35%) and brokers (1.18%). Meanwhile, capital goods (-0.08%) was the single lowest performer in the IG index and the only sector to deliver a negative credit return YTD. Again, even within the corporate sector, this demonstration of performance does not account for variability of returns throughout the year, but rather depicts the net performance in aggregate.
Exhibit 5. 2024 YTD excess and total returns by IG corporate sectors
Source: Santander US Capital Markets LLC, Bloomberg/Barclays Banking Indices, index duration in parentheses
When looking at the IG five-year spread percentile ranks, it is not surprising that financial sectors make up the bulk of the highest scoring segments of the asset class, but none score above their five-year median level, reflecting that spreads have largely held in despite trading off their tights throughout June and July. The weak performance in capital goods propelled the sector to the top five for spread opportunity for the remainder of the year. Despite their outperformance YTD, financials still also do appear poised for outperformance relative to industrials and utilities and should be overweighted for the remainder of ‘24, but within the limitations of the broader asset class’ expected performance.
Exhibit 6. 5-year spread percentile ranks and OAS by IG corporate sector
Source: Santander US Capital Markets LLC, Bloomberg/Barclays Banking Indices
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