Bond Bonanza Gives Traders a Chance to Tidy Up
(Bloomberg Opinion) — The U.S. bond market is having a September to remember as far as debt sales are concerned. Investors ought to use this borrowing binge to their advantage.
Investment-grade companies issued some $74 billion of debt last week, a record for any comparable period since at least 1972, and it looks as if an additional $35 billion is on the way in the coming days. More than $11 billion of asset-backed securities and commercial- and residential-mortgage debt is being pitched to investors, Bloomberg News’s Adam Tempkin reported. The leveraged-loan market has 12 bank meetings lined up, and a high-yield deal or two seems likely.
Much of the focus of this borrowing spree has been on the companies themselves, and rightly so. After all, it’s not every day that a company like Deere & Co. can set a record for the lowest-yielding 30-year investment-grade corporate debt, or Apple Inc (NASDAQ:). issues long bonds despite holding more than $200 billion of cash and investment securities. As I’ve written before, companies’ decision-making is fairly simple: They see low yields, and they sell bonds.
However, this should also be a time for investors to get introspective. Even with the wide swing in benchmark U.S. yields, spreads in corporate credit markets have remained remarkably steady. Since the start of August, yields have declined about 50 basis points on the 30-year Treasury and 40 points on the 10-year. Yet during that same period, the average investment-grade spread is up only 10 basis points. It’s roughly the same in the high-yield market, where spreads are below their 2019 average. Leveraged-loan prices have barely budged in recent weeks.
In other words, there’s still time to clean up bond portfolios heading into the final months of 2019. I imagine it can be hard for investors to deviate from their strategies, considering the staggering total-return figures across debt markets this year. But looking at the gains in the context of recent history starts to paint a clearer picture:
- U.S. investment-grade corporate bonds: 13.7% (on pace for highest since 2009)
- U.S. high-yield bonds: 11.3% (highest since 2016)
- U.S. Treasuries: 8.4% (highest since 2011)
- U.S. leveraged loans: 6.4% (highest since 2016)
- U.S. mortgage-backed securities: 5.5% (highest since 2014)
- U.S. asset-backed securities: 4.3% (highest since 2011)
Clearly, speculative-grade securities aren’t flying quite as high as they might initially appear. By contrast, the fact that the asset-backed securities index, stuffed with triple-A rated obligations, is quietly having its best year in recent memory indicates investors’ preference for higher-quality bonds.
Of course, the blistering rally in investment-grade corporate bonds can’t be separated from the huge increase in negative-yielding debt worldwide. Its proliferation has created a conundrum for investors in Europe and Japan because even 10-year Treasuries yield less than zero after hedging for currency risk. But in both regions, the yield turns positive by picking up an average U.S. corporate bond. Tetsuo Ishihara, a U.S. macro strategist at Mizuho Securities USA who has his finger on the pulse of the Japanese markets, said in a recent report that he had heard “retail consensus in Japan is that the US 30y is heading to 0%” over the next several years. As a result, “US IG is also a target for both retail and wholesale.”
Back in the U.S., some big money managers are advocating the “up in quality” trade (or, at least, voicing concerns about riskier securities). In a Financial Times Q&A about negative-yielding debt — with questions like “Is there a bubble in the bond market?” and “Will there be a damaging crash?” — JPMorgan (NYSE:) Asset Management’s Bob Michele stressed that “Investors should improve the credit quality of their holdings and concentrate primarily on positive yielding investment grade rated bonds.” BlackRock Inc (NYSE:).’s Rick Rieder said the riskiest areas and those offering the least value are “loan markets, especially in sectors where credit quality and covenants are weak.” Daniel Ivascyn, group chief investment officer at Pacific Investment Management Co., answered the same question by pointing to parts of the credit markets with deteriorating fundamentals and investor protections.
None of this is to say that riskier debt will deliver imminent losses. In fact, high-quality sovereign debt was the big loser on Monday, with yields rising on Treasuries and German bunds ahead of a potentially hawkish European Central Bank meeting and amid speculation that Germany is considering a “shadow budget” to bolster public investments, providing a much-needed fiscal boost to its economy.
The slow-but-steady economic growth since the financial crisis, combined with ever-accommodating central banks, has made reaching for yield the obvious trade. Sure, some energy companies crashed and burned along the way, and retailers have floundered, with discount merchandise chain Fred’s filing for Chapter 11 bankruptcy protection on Monday and Forever 21 Inc. perhaps up next. Yet by and large, companies have endured during the longest expansion on record, aided by low interest rates. Fixed-income investors have been rewarded handsomely along the way.
The reasons to believe that trend can’t last are beginning to pile up. There’s the yield curve, of course, which has been inverted for just about all of the past three months. But notably, as Shawn Donnan wrote for Bloomberg Businessweek, recession is becoming a reality in at least some corners of America, like manufacturing and agriculture. U.S. consumers have been a resilient part of the recovery, but as Komal Sri-Kumar noted in a Bloomberg Opinion column last week, their spending habits are hardly a leading indicator. And their outlook for the economy is slumping.
Bond investors, who clearly fear nothing more than a liquidity crunch during a rush to the exits, probably shouldn’t wait to see whether recession fears were overblown or warranted. This month’s supply offers a convenient opportunity for them to tidy up their holdings and position for a time when making money in fixed income isn’t quite so easy.