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Written by: Tim Benzel, CFA, VP & Sr. Portfolio Manager
As we discussed on our quarterly webex last week, we opined that the market has moved from Phase I of this crisis, which was driven by illiquidity, into Phase II, which will be driven by credit fundamentals.
On that topic, we recently wrote on the municipal market and what we believe to be key factors underpinning municipal credit.
For the corporate bond market, there are several moving parts to consider when analyzing where things stand. For this, we turn to the big three factors that underpin corporate bond performance: fundamentals, technicals and valuations.
The fundamental piece of the puzzle is bleak. Last week the IMF forecasted the world will experience the worst downturn since the Great Depression with GDP down 3%. Compare this to the 0.1% contraction in world GDP during the global financial crisis of 2009. Against this very negative GDP backdrop, wall street equity analysts are forecasting a 30% drop in S&P 500 earnings this quarter and an 8% drop for the full year. Current projections are for a snapback of 19% in 2021. We think these estimates are too optimistic and expect more negative earnings revisions to come, which may result in some volatility.
While fundamentals are weak, technicals are quite strong as the Federal Reserve has acted quickly and aggressively to prop up the market. The Fed has announced several conventional policies (rate cuts, quantitative easing), and unconventional policies (primary and secondary corporate facilities), to support liquidity. It is these unconventional policies that will likely have the greatest impact on the corporate market. When there is a deep pocketed buyer such as the Fed actively involved in a market, solid performance has typically followed.
Turning to valuations, the credit spread, which measures the additional yield investors demand to own corporate bonds versus US Treasurys, of the Bloomberg Barclays US Corporate Bond Index currently stands at 206 basis points, down from a peak of 373 basis points on March 23rd, but well off the sub-100 basis point level before the crisis took hold in late February. Compared to past periods of market angst, we are currently near where spreads were in 2016 (commodity price collapse), and about 40 basis points tight to 2011 levels (European sovereign debt crisis).
Taken all together, we believe the market is fairly priced at this juncture and expect it to trade sideways for the next several weeks. Over the medium to long-term we expect spreads to tighten. We are also hearing that May is set up to be a large month for new corporate bond issuance, which should provide plenty of opportunities. Historically, these types of levels provide compelling entry points for investors into the corporate market, which we believe will likely prove true this time around. But until we get a handle on the medical side of this crisis, we expect there to be pockets of near-term volatility.
Related: How We Are Thinking About Municipal Credit in This Environment
Source: Bloomberg, 4/20/2020
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