The Long and Short
Looking back and forward for sector allocation
This material is a Marketing Communication and does not constitute Independent Investment Research.
The primary market took center stage to start January as nearly 60 borrowers priced over $90 billion in investment grade new issues. Secondary spreads held in well. A look back at last year’s excess and total returns helps frame current spread valuations as investors make allocates for the new year. And 5-year percentile ranks help identify value, with the prospect of mostly carry trades driving performance in the months ahead.
Taking a step back to consider how corporate bonds have fared relative to broader fixed income in 2025, investment grade corporates provided total return of 7.77% throughout the year with a modest excess return (credit return net of treasuries) of 1.25%. On that basis, corporates outperformed securitized lending categories ABS and CMBS, but lagged the excess returns generated in MBS as well as both the high yield market and emerging markets (exhibit 1). The investment grade corporate index began the year at an historically tight level of approximately +80 OAS, with net tightening of only two basis points, and relegating credit performance in the sector to largely a modest carry trade on a full-year basis.
Exhibit 1: Broad fixed income performances in 2025
Source: Santander US Capital Markets LLC, Bloomberg fixed income indices
Within the index, the sectors that outperformed on an excess return basis in 2025 were largely banks, capital goods, non-cyclicals and energy (Exhibit 2). Not surprisingly, communications (dragged down by idiosyncratic credit situations) and technology (impacted by tremendous issuance in the later months) were the bottom performers for the year.
Exhibit 2: Investment grade sector performances in 2025
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 five-year trading ranges allowing for quick comparisons relative to where the broad index is currently valued (exhibit 3). While valuations in investment grade corporates are thin at just 8% of the five-year range, both EM and HY are running even tighter against historicals after outperformance throughout the prior year period.
Exhibit 3: Broad fixed income sectors – current spread percentile ranks (vs five-year trading range)
Source: Santander US Capital Markets LLC, Bloomberg fixed income indices
On that basis, most of the sectors of the investment corporate market offer very limited room for spreads to compress further and generate excess returns (exhibit 4). 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, technology and finance companies remain at the top of the list. But perhaps less surprisingly, the spread opportunity currently available according to historical trading ranges continues to favor banking, as well as natural gas despite above average credit returns in the prior year period. Still, the recommendations for potential overweight positioning relative to the index are utilities, natural gas, and energy (midstream) utilities, natural gas, and energy (midstream).
Exhibit 4: Investment grade sectors – current spread percentile ranks (vs five-year trading range)
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). 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 IG index. Meanwhile, technical supply pressures appear likely to weigh on performance in some of the higher percentile ranks indicated on the right side of the graphic.
Exhibit 5: Investment grade non-financial subsectors – current spread percentile ranks (vs five-year trading range)
Source: Santander US Capital Markets LLC, Bloomberg fixed income indices
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