Morningstar Corporate Credit Research Highlights

Metrics reported last week continued to indicate that economic growth is still building, which provided the support for asset markets to trade higher. Once again, major U.S. stock market indexes hit all-time highs, and corporate credit spreads ground tighter. The average spread of the Morningstar Corporate Bond Index, our proxy for the investment-grade bond market, tightened 2 basis points to +124 last week, and in the high-yield market, the credit spread of the Bank of America Merrill Lynch High Yield Master Index tightened 4 basis points to +386.

While current levels are wider than their historical lows reached in 2007, the current levels in the corporate bond markets are the tightest that credit spreads have registered since the fall of 2014 and significantly tighter than their long-term averages. The average spread of the Morningstar Corporate Bond Index is 44 basis points tighter than its long-term average of +168 since the end of 1998. The average spread of the Bank of America Merrill Lynch High Yield Master Index is currently 194 basis points tighter than its long-term average of +580 basis points since the end of 1996.

As an indication of how tight corporate credit spreads have become compared with their historical averages, since the beginning of 2000, the average spread of the Morningstar Corporate Bond Index has registered below the current level only 27% of the time. The preponderance of the time that the index resided at a level tighter than the current credit spread, occurred during the buildup to the 2008-09 credit crisis. In 2004 through 2007, corporate credit spreads were pushed to historically tight levels as new structured investment vehicles were engineered to arbitrage the differentials in expected default risk; however, once the credit crisis emerged, investors found that many of these vehicles did not perform as advertised.

In the high-yield market, corporate credit spreads have been even tighter compared with their long-term historical averages. Based on the current spread level, the average spread of the Bank of America High Yield Master Index has registered below the current level only 17% of the time.

After a record amount of new issuance was brought to the corporate bond market in January, the new issuance market has returned to a more normalized pace thus far in February; however, trading volumes remained well above average as the corporate bond market is continuing to digest the large deals brought to market in late January. According to Bloomberg, of the five highest trading sessions since the data began in 2005, four have occurred this year, with the other session having occurred last November. In addition, six of the top 10 highest-volume sessions have occurred just this year.

While trading levels have surged in the secondary market, investors remain especially cautious. Fund flows into the high-yield asset class were essentially unchanged last week. The small amount of inflows into open-end mutual funds offset the amount of outflows among the exchange-traded funds.

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