Tuesday, June 29, 2021
While most of the focus lately has been on the volatility in the Treasury markets, the corporate credit markets continue to tell an encouraging story about the economic recovery. The traditional U.S. corporate credit bond market represents roughly $8.5 trillion in debt outstanding from both investment grade and non-investment grade issuers. Companies, large and small, access the credit markets to help fund operations and improve their financial health. Last year, these companies issued more than $2.3 trillion in debt, which was one of the strongest issuance years ever. The robustness of the corporate credit markets is a positive sign for both equity and credit market investors.
“Credit markets tends to lead equities lower during market stresses so that we’re not seeing volatility in the credit markets is a good sign for equity investors as well,” noted LPL Financial Fixed Income Strategist Lawrence Gillum.
As seen in the LPL Research Chart of the Day, since the COVID recovery, option-adjusted spreads (OAS) remain well-behaved. OAS represents the compensation for holding risky debt and, generally speaking, corporate credit OAS is a good barometer for the overall health of the economy. So, that both investment grade (blue line) and non-investment grade (orange line) companies have seen their borrowing costs fall suggests the corporate sector is in good shape. Additionally, despite volatility in the Treasury markets, we haven’t seen the same volatility in corporate credit spreads, which is a good sign that the economic recovery is well underway. During periods of economic stress, such as in spring 2020, credit spreads widened, whereas now we continue to see spreads grinding tighter.
From a fundamental perspective, broadly speaking, corporate balance sheets are in good shape. Leverage ratios have increased recently, but net-debt ratios (debt minus cash on the balance sheets) remain within historical norms. Also, due to the record amount of issuance over the last few years, companies were able to refinance debt at very low interest rates and push back when that debt was set to mature. As such, interest expenses have come down and now many corporations don’t need to access the capital markets anytime soon. What could push spreads wider? Outside of a broad macro event, we continue to watch how these companies manage capital allocation decisions. Increases in M&A activity, share buybacks and outsized dividends are all risks to bondholders and things that could push spreads higher.
So, while the fundamental landscape for corporate credit markets remains favorable, valuations remain stretched. All-in yields and spreads remain amongst the lowest they’ve ever been. We remain neutral on investment grade corporates but prefer the short-to intermediate maturity part of corporate curve. We’re less sanguine on non-investment grade bonds solely because of valuations. We still think equities offer more upside than non-investment grade bonds the remainder of 2021.
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