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What's Holding Back Investment-Grade Corporate Bonds?

Dave Sekera, CFA

Dave Sekera: Although earnings reports have been generally mixed and fourth-quarter GDP was below the average consensus estimate, investors have continued to bid up the prices of risk assets in anticipation of faster economic growth ahead. Within the corporate bond market, the high-yield sector has significantly outperformed the investment-grade sector. While the average spread of the Morningstar Corporate Bond Index was relatively range-bound and only tightened 2 basis points year to date, the average spread of the Bank of America High Yield Index has tightened 30 basis points through Feb. 6.

Part of the reason that credit spreads in the investment-grade market have languished has been driven by a healthy dose of $178 billion worth of new issues priced in the corporate bond market, which was priced here in January.

Last week Microsoft brought to market a $17 billion transaction. In December 2016, Morningstar Credit Ratings downgraded Microsoft to AA+. Our downgrade took into account the company's trend toward higher use of debt, a more aggressive shareholder-payout policy, and funding for the acquisition of LinkedIn. Apple also brought a large deal to market, pricing a $10 billion, multitranche new issue. In our view the firm's credit profile has been affected by management's trend toward more aggressive capital allocation and a dramatic increase in debt. We currently have a negative outlook assigned on our credit rating for Apple.

Our credit ratings may differ from those of other rating agencies. Our methodology emphasizes our forward-looking view which is encapsulated within our credit rating criteria.

With the abundance of new issuance floating around the market, secondary market trading levels have been regularly hitting new highs. According to Bloomberg, secondary trading volume in the investment-grade market rose to $28.2 billion on Tuesday last week--the single greatest amount of daily trading volume since 2005 when the data first began. Of the top five greatest daily trading sessions, three have occurred in January alone and the other two days occurred late last year.