Trade and Oil Concerns Boost Spreads to Two-Year Highs

Credit markets are now sharing global stocks’ angst over trade and oil.

As shown in the LPL Chart of the Day, credit spreads on investment-grade and high-yield corporate debt have jumped to their highest levels since December 2016. Higher credit spreads have followed a swift increase in credit-default swap spreads, which we highlighted in a blog post last month.

Corporate Debt Spreads Jump to Two-Year High

The U.S.-China trade dispute has exacerbated concerns about U.S. companies’ health. While we believe the U.S. and China will eventually reach an agreement and avoid any significant economic impacts, trade tensions have increasingly weighed on economic data as input costs rise, supply chains show increased stress, and producers brace for continuing uncertainty. Domestic business investment has slowed over the past few months, and manufacturing health has declined globally, hinting at cooling economic growth. Longer-term rates have climbed recently to the highest level in seven years, increasing worries that U.S. companies may have a tougher time servicing debt or refinancing if the economy slows.

Oil has also fallen into a bear market, fueling anxiety that the swift drop in crude could be indicative of a broader global slowdown. Energy debt is also one of the highest weighted groups in the high-yield spread index we track (the Bloomberg Barclays Corporate High Yield Index), so energy companies’ yields could have a greater effect on overall spreads.

Still, spreads are relatively low compared to where they’ve been over the past few years, and U.S. companies’ financials are encouraging to us. Debt-to-earnings ratios for S&P 500 Index companies remain manageable, and firms’ free cash flow is at a cycle high.

“We expect financial-market volatility to subside as investors focus more on fundamentals,” said LPL Chief Investment Strategist John Lynch. “Companies’ balance sheets remain strong, thanks to solid economic growth and strong corporate profits.”

Going forward, we believe U.S. corporate health will be aided by accelerating consumer demand and the tailwind of fiscal stimulus amid manageable inflation. We expect higher productivity and growth in capital expenditures to drive corporate profits and late-cycle output growth.

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Yield Spread is the difference between yields on differing debt instruments, calculated by deducting the yield of one instrument from another. The higher the yield spread, the greater difference between the yields offered by each instrument. The spread can be measured between debt instruments of differing maturities, credit ratings and risk.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

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