Not a Lot of Upside for Corporate Bonds
Although spreads could grind a bit tighter in the near term, rising interest rates will be a headwind.
Although spreads could grind a bit tighter in the near term, rising interest rates will be a headwind.
David Sekera: The Morningstar Corporate Bond Index rose about 1% in October, predominately due to declining interest rates during the month. Year to date, the index has risen about 6.7%, which has outperformed our expectations that we had initially going into this year.
Now, while we have been correct that corporate credit spreads would trade in a relatively narrow range over the course of the year, where we are incorrect was that we thought interest rates would normalize or rise slightly over the course of the year, whereas they've actually decreased. Thus far this year, the 10-year Treasury, for example, has decreased about 70 basis points and is currently at about 2.3% right now.
There was a brief correction in the stock market earlier in October as the S&P 500 had fallen about 10% on an intraday low off of its highs for the year. However, the stock market quickly rebounded. It is now hitting new highs again. However, when we compare the action in the corporate bond market, there is a little bit of the dislocation.
So, for example, the average spread in the Morningstar Corporate Bond Index right now is 125 basis points. Earlier this year in June, it had gotten as low as 101 basis points. In the high-yield sector, we see similar action in the high-yield universe. So, for example, the Bank of America Merrill Lynch Index was about 335 basis points in June, had risen quite substantially with that correction in October, has rebounded and is now at about 435 basis points.
In the short term, we do expect credit spreads will probably continue to grind tighter over the remainder of the fourth quarter as the economic momentum that we saw in the third quarter carries over into the fourth quarter.
However, for the medium term, we still contend that interest rates should rise and normalize over the next coming 12 to 18 months. As the Fed has exited its asset purchase program and we still expect 2% to 2.5% GDP growth, we really expect interest rates more to go up toward that 3% level on the 10-year as we really just compare what interest rates should be compared to normalized metrics on inflation expectations in the shape of the yield curve.
Thus, we will probably see the tightening credit spreads offset by the rising interest rates, and so therefore, we expect that the investors in high-yield as well as investment-grade will probably earn their carry over the course of the year, but we really don't expect to see further upside from there.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals
and individual investors. These products and services are usually sold through
license agreements or subscriptions. Our investment management business generates
asset-based fees, which are calculated as a percentage of assets under management.
We also sell both admissions and sponsorship packages for our investment conferences
and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.