Corporate Credit in 2014, What You Might Have Missed

Investors were not compensated for taking corporate credit risk in 2014 with corporates underperforming slightly according to Bank of America Merrill Lynch Index data. The year began with cold weather’s negative impact on economic activity that was eventually supplanted by strong domestic economic growth and declining equity volatility. Corporate spreads bottomed in June only to rise again (in a “U” shape) on jitters surrounding low global growth and plummeting oil prices as the year came to a close. Corporate bonds of differing tenor, quality and sector produced a variety of results. In terms of excess return over comparable Treasury bonds, the top performing segments of the corporate universe included the five-to-seven year portion of the corporate curve, which tightened as underlying Treasury yields rose in that segment. BBB-rated corporates fared better than higher-rated credits, as equity volatility, 54% correlated with credit spreads in 2014, dropped during the first half of the year (see chart below), only to underperform in the final months of 2014 as volatility returned. The energy sector dominated the discussion as the precipitous drop in oil prices caused investors to feel shaky about future earnings, which eventually make their way back to balance sheets via retained earnings. Financials, including SNWAM holding J.P. Morgan, performed well as global regulation standards increased and several large mortgage crisis-related litigation matters were put to rest. Looking forward, we expect banks and other financials to tighten incrementally more than other sectors as balance sheets continue to improve in response to evolving bank supervision standards. We expect the effects of lower oil prices to favorably affect balance sheets for names like Wal-Mart, which we added to portfolios recently, and unfavorably affect oil and gas servicers like Schlumberger, whose growth depends on the profitability of additional drilling. Although we expect gyrations in corporate spreads in 2015 as the markets acclimate to an expected policy rate increase by the Federal Reserve, we are broadly encouraged by stable credit metrics and macro factors like solid U.S. job and economic growth.

Source: Bank of America Merrill Lynch