Blue-Chip Corporate Debt Is the Market's Least-Loved U.S. Asset
(Bloomberg) -- Blue-chip corporate bonds are on track to be the worst-performing U.S. asset class this year, and money managers caution that it may be too soon to start looking for bargains.
The strong economy is triggering fears of rising inflation and unexpectedly fast Federal Reserve rate hikes, which have weighed on both U.S. Treasuries and investment-grade corporate bonds. On top of that, American companies are borrowing more and their interest costs are rising relative to their income.
It’s not clear how much longer the pain will persist for investment-grade bonds. Issuance is likely to slow down in the second half of the year, cutting into supply, and foreign buyers may be more inclined to buy now as the U.S. dollar appreciates. That makes it tricky to figure out when to snatch up the securities, said Brian Kennedy, a portfolio manager at Loomis, Sayles & Co.
“There’s certainly more value today than there was six months ago -- that’s indisputable,” Kennedy said. “But investment-grade debt is still not giving you enough yield to totally offset rate hikes at this point.”
Beat-Up U.S. Corporate Debt Looks Bad: Read the Weekly Credit Brief.
Investment-grade corporate debt has fallen 3.3 percent this year through June 28 on a total-return basis, on track for the worst first half of a year since 2013, according to Bloomberg Barclays index data. The notes have lagged Treasuries and mortgage bonds, while junk bonds have eked out gains.
“It’s been a challenging year,” said Matt Brill, a senior portfolio manager at Invesco Ltd., which managed $237 billion of fixed income assets as of April 30. While high-yield debt is still performing well, “In investment-grade, you have all sorts of problems.”
Overall corporate profits rose nearly 25 percent in the first quarter thanks in large part to tax cuts, according to data compiled by Bloomberg. But that’s not necessarily trickling down to debt investors, according to Morgan Stanley. Blue-chip U.S. companies’ median gross leverage, or debt relative to earnings before interest, taxes, depreciation and amortization, edged higher in the first quarter to 2.5 times, the second-highest level on record, Morgan Stanley strategists led by Adam Richmond wrote in a report this month.
The ratio of Ebitda to interest expense, known as the interest-coverage ratio, fell to 9.92 times, the lowest level since the crisis, signaling that companies have a lower earnings cushion for meeting their obligations, the strategists wrote.
This weakening in credit metrics comes as the market has grown much bigger. Low rates have helped fuel record borrowing from investment-grade companies, allowing the value of outstanding debt to more than double over the last decade to $5 trillion.
“There’s been a lot of issuance,” said Dan Ivascyn, group chief investment officer at Pacific Investment Management Co. “We’re late in the cycle. We’ve got a Fed in play. Trade uncertainty. You have the political uncertainty that’s real and is in front of us.”
Pimco, which oversaw $1.77 trillion of assets as of March 31, is cautious on credit overall, with particular concerns about high-yield debt, Ivascyn said.
Some investors are starting to think about bargain shopping. The Fed’s preferred inflation gauge is near its target, and Treasury yields may have peaked for the year, possibly setting up investment-grade debt for a turnaround.
“You’re held a little captive to what happens in the Treasury market in terms of returns, but investment-grade is still a relatively safe place to be,” said Marc Kremer, a portfolio manager at Franklin Resources Inc.’s Franklin Templeton Investments unit.
There may also be technical reasons for corporate bonds to improve. Bank of America Corp. strategists led by Hans Mikkelsen forecast that issuance could slow in the second half of this year. And foreign investors who don’t hedge their holdings may be drawn to the debt after the dollar has strengthened relative to the euro and the yen, said Nathaniel Rosenbaum, credit strategist at Wells Fargo.
Even so, in the end, much of the performance of corporate bonds depends on overall liquidity. The Fed is on track to hike rates at least twice more this year. Worldwide monetary policy will slip into contraction in six to eight months. Quantitative tightening, or the unwinding of central banks’ extraordinary stimulus, has been the primary driver of assets’ performance this year, Bank of America analysts said.
“Whatever the Fed has giveth for the past eight years is being taken away right now,” said Peter Strzalkowski, co-team leader of the investment-grade debt team at OppenheimerFunds.
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