The Long and Short
Looking to financials, natural gas, energy, utilities
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.
The investment grade corporate bond index traded at year-to-date tights in the past week even as broader markets have recently adopted a renewed focus on tariff uncertainty. That helps frame the context of current spread valuations, which may appear limited in aggregate but with opportunities to target specific areas that may still have room to run. Among those that stand out include financials, as well as areas of natural gas, energy and utilities.
Taking a step back to consider how corporate bonds have fared relative to broader fixed income, investment grade corporates provided total return of 3.78% in the first roughly six months of the year with a modest excess return (credit return net of treasuries) of 0.47%. On that basis, corporates outperformed all broad securitized lending categories (ABS, MBS, CMBS) in the first half of the year, but fell short of excess returns in both the high yield market and emerging markets (Exhibit 1). The investment grade index began the year at an historically tight level of approximately 80 bp OAS, only to travel roundtrip to its current valuation of about 81 bp, relegating performance in the sector to largely a modestly carry trade year-to-date comprising the bulk of credit returns.
Exhibit 1: Broad fixed income performances year-to-date
Source: Santander US Capital Markets LLC, Bloomberg fixed income indices
Within the index, the sectors that outperformed over that period were largely non-cyclicals, including some of the financials, consumer non-cyclical and capital goods (Exhibit 2). Commodities and cyclicals rounded out the bottom of the spectrum, with natural gas, utilities and energy among the worst performing segments of the index. Communications and transports were also among the bottom performances, though both saw idiosyncratic situations on large index constituents (WBD and the large FDX exchange, respectively) greatly influence performance in each of those segments in the first half of the year.
Exhibit 2: Investment grade sector performances year-to-date
Source: Santander US Capital Markets LLC, Bloomberg fixed income indices
The investment grade index reached its year-to-date wide level OAS of 119 bp on April 8 at presumably the peak of post Liberation Day tariff concerns. Spreads tightened rapidly from that level to their year-to-date tight of 77 bp established just ahead of the July 4 holiday. During that run, commodities and cyclicals led the charge tighter, with the energy and basic materials sectors topping the overall performance over those roughly three months (Exhibit 3). Meanwhile, utilities, banks and consumer non-cyclicals had the least room to recover as the market quickly recalibrated tariff concerns.
Exhibit 3: Investment grade sector performances since 04/08/25 tariff wides
Source: Santander US Capital Markets LLC, Bloomberg fixed income indices
Percentile rankings can serve as a rich/cheap analytic based on historical trading levels. Current OAS for a given sector generates a percentage of the 5-year trading ranges allowing for quick comparisons relative to where the broad index is currently valued (Exhibit 4). On that basis, most of the segments of the investment grade market offer very limited room for spreads to compress further and generate excess returns (left side of the grid). However, some of the sectors still provide upside, albeit on the limited basis with spreads bumping up against the local tights (right side of the grid). Not surprisingly, consumer cyclical (such as autos) remains at the top of the list. But perhaps less surprisingly, the spread opportunity currently available according to historical trading ranges favors financials, as well as segments of energy/utilities/natural gas. Investors should target overweight positions in these areas of the index, while recognizing the limited upside currently available in basic materials and non-cyclicals, such as capital goods, TMT and consumer non-cyclical.
Exhibit 4: Investment grade sectors current 5-year spread percentile rank
Source: Santander US Capital Markets LLC, Bloomberg fixed income indices
Drilling a layer deeper to index subsector provides a more detailed landscape of where opportunity lies within the investment grade market (Exhibit 5). Furthermore, taking into consideration some of the still very real uncertainties regarding tariffs in addition to the available opportunity set in each subsector allows investors to narrow the focus even further. In that context and given the consistency of cash flows amidst varying political and economic outcomes, midstream/pipelines, electric utilities, and natural gas appear attractive segments of the market for investors to target overweight positions in the non-financial sectors of the investment grade index.
Exhibit 5: Investment grade non-financial sectors 5-year spread percentile rank
Source: Santander US Capital Markets LLC, Bloomberg fixed income indices
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