The Long and Short
A look back at sector spreads during the 2018 trade war
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.
This is not our first trade war, so it helps to look back at how the war of 2018-2019 affected the investment grade corporate bond market. Corporate bond spreads began widening in early 2018 and then peaked toward the end of the year before gradually recovering throughout much of 2019. Spreads hit local tights just before the global pandemic. Examining historical spreads over that stretch offers some insight into how different sectors might perform if current conditions escalate.
Let’s start with individual sector total and excess returns over the time period in 2018 when tariff concerns began affecting spread performance (Exhibit 1). Those concerns peaked at the start of 2019. Focusing on excess returns shows how each sector performed as spreads widened through 2018, independent of rate moves that would vary from sector to sector and affect total return. The most sensitive sectors over that period appeared to be finance companies, natural gas, transportation and basic industry; while the financial segments and communications appeared to offer the most relative stability based on excess returns over that same period.
Exhibit 1. Investment grade sector returns as tariff concerns widened spreads
Source: Santander US Capital Markets LLC, Bloomberg Investment Grade Corporate Index Returns
We can also focus on the consumer and industrial sectors of the investment grade corporate bond index and see how spreads performed over that stretch of time versus the broad index (Exhibit 2). There do seem to be some discrepancies in how the individual sector indices performed versus the sector returns of the aggregate investment grade index, but overall the trends do appear mostly consistent. Communications stands out with wide spreads but at the time was reflecting a number of ongoing M&A sagas playing out, mostly unrelated to the trade war, that were contributing to notably wider spreads. Most of these industrial sectors kept spreads tight to the index. However, based on excess returns, communications and technology delivered better numbers than the index and could be considered defensive while all other sectors delivered worse numbers than the index.
Exhibit 2. IG Consumer/Industrial sector spreads during 2018-2019 trade war
Source: Santander US Capital Markets LLC, Bloomberg Sector Corporate Indices (OAS)
We can focus next on the financial sectors of the index through the 2018–2019 period. Another big standout with spreads spiking much wider than the rest of the market is observed in the finance companies segment. This is likely due to the large concentration of aircraft lessors in that particular sector of the index at the time. In the years since then, and particularly over the past two years, the composition of the finance companies sector has changed considerably with a dramatic rise in issuance from business development companies (BDCs). Those BDC credits now make up a much larger portion of the index and dictate much more of the collective performance of the sector. With that being the case, the expectation would be that fincos would exhibit less volatility than the last trade war if conditions were to worsen and spreads overall were to begin widening. However, it does remain a very high beta portion of the index and would likely see outsized selling during any periods of heightened volatility for investment grade credit, while bigger segments such as banking/insurance would provide more defensive posture against spread widening. In the 2018-2019 war, banking brokers and REITs proved the defensive play, based on excess return.
Exhibit 3: Investment grade financial sector spreads during 2018-2019 trade war
Source: Santander US Capital Markets LLC, Bloomberg Sector Corporate Indices (OAS)
Finally, let’s turn to energy, utilities and basic materials. Clearly, the energy and basics segments saw outsized bouts of volatility as trade-related spread widening took hold in the market throughout 2018 and on into 2019. Investors most concerned with tariff-related volatility would seek to underweight these segments of the market if they believed that conditions would worsen over time and retaliatory policies potentially escalated abroad. All of these sectors underperformed the index, based on excess return, during the last trade war.
Exhibit 4: Investment grade energy/utilities/basics sector spreads 2018-2019
Source: Santander US Capital Markets LLC, Bloomberg Sector Corporate Indices (OAS)
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