The Big Idea
Lessons learned in corporate credit 2024
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 corporates largely ran in one direction in 2024, with only a few caveats, as spreads moved tighter for the bulk of the year. The investment grade index bottomed out at an historically tight level of 74 OAS following the election, before settling several basis points wider into year-end. Given these pressures, timing the market proved difficult throughout the year on individual credit situations with higher beta profiles. Meanwhile, sticking to convictions on sector weightings were an important component of portfolio performance as the market closed out the year in a mostly ”risk-on” posture.
Timing the market proved difficult for higher beta credits in 2024
Two of the more prominent calls in corporate credit in late third quarter involved higher-beta names that were under considerable pressure at the time, Ford Motor Co (F: Ba1/BBB-/BBB-) and Ally Financial (ALLY: Baa3/BBB-/BBB-). ALLY had just recently warned about weaker credit results in its auto book at the Barclays banking conference and was approaching a critical earnings report that would potentially spell out the extent of the difficulties at its lending operations. Meanwhile, F was gapping wider on warnings throughout the industry that upcoming results could come under pressure, and perceptions that rate cuts would not provide material relief to the domestic OEMs.
Santander US Capital Markets recommendations:
In both cases, underlying credit conditions at the issuers appeared very solid, and therefore longer-term valuations of the companies remained intact. Instead, these credit calls were an attempt to maximize value before establishing or increasing exposure to the bonds, with expectations for spreads to move wider in the near-term.
Macro trends for the investment grade corporate bond market quickly shifted, leaving only a narrow window for investors to execute on either of these recommendations before spreads rapidly began moving tighter with the broader market (Exhibit 1). This served as an important reminder that its extremely difficult to fight the Fed, and that high beta credits are often more influenced by broader perceptions on credit conditions than the micro implications of headlines or even important earnings results. In both of these cases, these credits now remain among top picks for potential outperformance in 2025, with the out-of-consensus macro view for credit spreads to remain at or near historically tight levels throughout at least the first half of next year, and potentially further into the future.
Exhibit 1: F and ALLY 5-year CDS pricing trends throughout 2024
Source: Santander US Capital Markets LLC, Bloomberg LP
Sticking to convictions on sector weightings key for portfolio performance
The first credit call that was published for 2024 on the first week of the year highlighted that 5-year percentile ranks of current spreads at the time heavily favored the financial sectors of the investment grade index to outperform in the coming year. Those sentiments were reiterated in August, as this “rich/cheap” analytic still heavily favored this sector weighting approach, despite many of those segments already outperforming for the first seven months of 2024.
Santander US Capital Markets recommendations:
Examining total returns and excess returns (credit return net of treasury return) by individual sectors within the investment grade index, the financial segments of the market clearly outperformed versus the broader index (Exhibit 2) year-to-date. Finance companies (4.18%), REITs (3.83%) and brokers (3.44%) all delivered excess returns among the top five performances within the IG universe. Meanwhile, finance companies (6.83%), banking (5.26%) and REITs (5.08%) were the top three performers in the entire index by total return for the year so far. Only the insurance segment fell just below the overall index in terms of both excess and total return. A large reason the sector slightly underperformed was likely due to the high overall duration of the bonds held within the segment, which would make them more subject to Fed-based trading throughout the year than the rest of the financials. The expectation for the banking sector to continue to outperform remains intact within the out-of-consensus calls for credit in 2025.
Exhibit 2: IG index sector (total and excess) returns year-to-date
Source: Santander US Capital Markets LLC, Bloomberg/Barclays corporate indices by sector
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