Credit’s Signals in Last Week’s Sell-Off

Last week’s sharp equity sell-off broke months of historic calm for U.S. stocks. As investors clamor for answers, we’ve provided our biggest takeaways from the bond markets response to the volatility.

Domestic credit markets were resilient, even as global equities fell the most since March 2018. As shown in the LPL Chart of the Day, investment-grade and high-yield spreads were subdued even as the S&P 500 Index fell nearly 7%.

Credit Spreads are Historically Low, Even Amid Stock Volatility

Typically, yields are a barometer of perceived risk in the corporate bond market. If investors expect higher future risk, they are likely to demand additional yield from issuers to compensate.

Investors piled into longer-term Treasuries, pushing up government bond prices and leading to yields and stocks declining together. While this risk-to-safety* pivot intuitively makes sense, it’s a rare trend in the current low-yield environment. Last week, the S&P 500 and the 10-year Treasury yield fell together for four straight days, the first time that’s happened since February 2016. The tandem drop in stocks and yields isn’t as surprising given the 10-year yield was due for a breather after swiftly rising to a seven-year high on October 5. Reports last week showed producer and consumer price growth remains manageable, and longer-term yields tend to fluctuate with inflation expectations.

Overall, our outlook on fixed income hasn’t changed. We still think bonds are an important part of portfolios, as they provide income and help mitigate the risk to a portfolio’s value during times of equity weakness (like last week’s event). We also believe the rally in rates may be done in the near-term, as 3.25% on the 10-year yield is the top of our year-end forecast. Contained inflationary pressures and Treasuries’ attractive valuations compared with relatively low government yields around the world may keep a lid on longer-term rates for now.

For more thoughts on last week’s volatility, check out this week’s Weekly Market Commentary: Perspective on Market Volatility.

IMPORTANT DISCLOSURES

*U.S. Treasuries may be considered “safe haven” investments but do carry some degree of risk including interest rate, credit, and market risk. They are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

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