The investment grade corporate bond market is notably weaker over the last few weeks. Corporates have underperformed relative to other investment grade sectors for most of 2018, but the velocity of the recent selloff is now front-page news. We are not surprised by this selloff and have been positioned for corporate weakness across our various strategies.
The recent widening in credit spreads can be attributable to a host of general market factors, including concerns over rising rates, trade wars, slowing growth in China and round the globe, increased geopolitical risk and a stronger dollar. In addition, credit spreads have been relatively tight compared to historical averages, meaning that corporates have not offered tremendous relative value. None of these factors are new.
On top of the general market factors, we have seen company specific problems with some issuers, including General Electric, Ford, and Pacific Gas & Electric. Taken together, these general and specific factors can cause investors to become bearish, and overly weak sentiment can accelerate spread widening.
And while our expectation is for corporate spreads to continue moving wider, we believe concerns over the corporate market may also be exaggerated by the market at this time. We see two major strengths keeping the corporate market upright in the face of current weakness. First, corporate profitability is robust and third quarter earnings in the S&P 500 (a good surrogate for the corporate bond market) were exceptional. Second, the U.S. economy continues to grow above trend, with the last quarter GDP at 3.5%, unemployment at 3.7% (remaining at 50 year lows) and core CPI at 2.1% (suggesting inflation is still tame).
These positives will likely keep the market from continuing to experience the current pace of spread widening. However, in the latter stages of an economic cycle where a central bank has been tightening monetary policy, we aren’t excited about adding exposure on this current bout of weakness, either. Instead, we are staying the course with our conservative positioning, continuing to keep a close eye on the issuers we do own and waiting for more attractive entry points before taking more risk.
Sources: Bloomberg, BofAML