Insights

Bond Valuations Remain Unfazed Monthly Credit Commentary – October 2023

16 November 2023

Matthew Nest, CFA

Global Head of Active Fixed Income

John P Mele, Esq.

Senior Portfolio Manager

Arkady Ho, CFA

Fixed Income Portfolio Strategist

Environment and Outlook for US Credit

As the march to the end of the economic cycle continues and growth and inflation slow further, the debate over how the cycle turn will play out – i.e. hard landing or soft landing – is likely to grow louder. With the Fed signaling “higher for longer,” interest rates and borrowing costs increasing significantly over the past 12-18 months, as well as rising and more acute geopolitical risks, one would have expected the environment for corporate credit to be challenged. However, bond valuations appear unfazed as investment grade (IG) corporate spreads remain well inside of the level we deem to be long run fair value, or roughly 145 basis points (bps).

Credit quality at the index level continues to improve. Positive credit ratings momentum continues in both investment grade and high yield. The upgrade/downgrade ratio for IG is 3.6x YTD after a strong 3.9x in 2022. The BBB rated segment of the index is at 47%, which is down from a peak of 51% in 2019.¹
Demand for long corporates remains strong. Lack of long end supply and higher all-in yields are driving demand for long paper – reinforced by corporate defined benefit pension plans continuing along their de-risking path as rates have moved higher.
Credit fundamentals have peaked, but they have not (yet) cracked. While top-line and bottom-line growth rates have slowed considerably, they remain positive (Figure 1). Despite this softening, corporate balance sheets remain well positioned to weather the coming economic slowdown.

Has the Value Factor Run Its Course in 2023?

As the Fed started tightening monetary policy in 2022, market volatility rose and credit spreads widened, creating more attractive compensation for risk. While the value factor in IG² exhibited weakness in 2022, year-to-date, it has performed well, with the top-quintile portfolio contributing significantly more to returns than the bottom-quintile portfolio (Figure 3). This trend has started to dissipate more recently; in September, value and momentum flipped, with value almost flat and momentum seeing its strongest performance since early 2023.

As IG corporate spreads have tightened back to 128 bps,³ a lot of those value opportunities have been harvested, and we may be seeing the initial signs that momentum in credit spreads may be turning as well. Overall, these are useful indicators to look at suggesting some caution ahead – corporate credit may start to feel the effects of tight monetary policy more clearly in the coming months.

Footnotes

Disclosure

Important Risk Disclosure

For institutional / professional investors use only.

ssga.com

State Street Global Advisors Worldwide Entities

Marketing Communication

Investing involves risk including the risk of loss of principal.

Information Classification: General

All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.

The views expressed are the views of State Street Global Advisors Fixed Income team through November 10, 2023, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward- looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected.

Diversification does not ensure a profit or guarantee against loss.

Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.

Barclays is not affiliated with State Street Global Advisors Funds Distributors, LLC.

Barclays Index License Disclaimer

Neither Barclays Bank PLC (“BB PLC”) nor any of its affiliates (collectively “Barclays”) is the issuer or producer of the products referenced herein and Barclays has no responsibilities, obligations or duties to investors in such products. The Barclays Indices referenced herein (collectively, the “Indices”), together with any Barclays indices that are components of such Indices, are trademarks owned by Barclays and, together with any component indices and index data, are licensed for use by State Street Global Advisors as the producer of the products referenced herein (the “Product Provider”). The Indices are used by the Product Provider in connection with the management of the products referenced herein, but the Indices are not used by the Product Provider as the benchmark for such products, as defined under Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds.

Barclays’ only relationship with the Product Provider in respect of the Indices is the licensing of the Indices, which are administered, compiled and published by BB PLC in its role as the index sponsor (the “Index Sponsor”) without regard to the Product Provider or the products referenced herein or investors in such products. Additionally, State Street Global Advisors as Product Provider may for itself execute transaction(s) with Barclays in or relating to the Indices in connection with such products. Investors acquire such products from the Product Provider and investors neither acquire any interest in the Indices nor enter into any relationship of any kind whatsoever with Barclays upon making an investment in such products. The products referenced herein are not sponsored, endorsed, sold or promoted by Barclays and Barclays makes no representation regarding the advisability of such products or use of the Indices or any data included therein. Barclays shall not be liable in any way to the Product Provider, investors or to other third parties in respect of the use or accuracy of the Indices or any data included therein.

Barclays has engaged Bloomberg Index Services Limited as the official index calculation and maintenance agent of the Indices, which are owned and administered by Barclays. Bloomberg Index Services Limited does not guarantee the timeliness, accurateness, or completeness of the calculations of the Indices or any data or information relating to the Indices. Bloomberg Index Services Limited makes no warranty, express or implied, as to the Indices or any data or values relating thereto or results to be obtained therefrom, and expressly disclaims all warranties of merchantability and fitness for a particular purpose with respect thereto. To the maximum extent allowed by law, Bloomberg Index Services Limited, its affiliates, and all of their respective partners, employees, subcontractors, agents, suppliers and vendors (collectively, the ‘protected parties’) shall have no liability or responsibility, contingent or otherwise, for any injury or damages, whether caused by the negligence of a protected party or otherwise, arising in connection with the calculation of the Indices or any data or values included therein or in connection therewith and shall not be liable for any lost profits, losses, punitive, incidental or consequential damages.

Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.

The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This communication is directed at professional clients (this includes eligible counterparties as defined by the appropriate EU regulator) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication.

Past performance is not a reliable indicator of future performance.

The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.

More on Systematic

View All Insights