A quick look at a timely topic of interest – with a brief review of why it could matter to investors.

Chart of the Week

September 7, 2015

Global spreads: rising to an opportunity?
Option adjusted spreads of select indices

chart

Source: Bloomberg, as of 8/31/15. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • Global growth concerns roiled financial markets recently, leading many bond investors to seek safety in less risky bond sectors – like U.S. Treasuries.
  • At the same time, investors demanded higher yields for riskier sectors like high yield bonds, especially those issued in emerging market countries.
  • That combined to sharply increase HY yield credit spreads.
  • Global corporate debt was also impacted, though to a far lesser degree, on the basis of the deflationary potential of a slowing Chinese economy – which could hurt revenues and corporate pricing power even in developed market companies, potentially affecting future profitability.
  • The question for investors is whether HY spreads will narrow again as the global economic landscape continues to evolve. If the selling continues yields and spreads could become even more attractive on an absolute and relative basis.
  • If so, investors with the risk tolerance and proper investment time horizon would be better compensated for accepting the current risks in these sectors than they were just a few months ago.
  • Certainly caution is warranted when uncertainty is rife, but markets sometimes quickly price in worst case scenarios that never actually pan out.
  • That could leave room for prices to move higher when the dust of anxiety settles.
  • Of course, uncertainty can't be diversified away, but proper diversification can help mitigate risks—something that active managers with a flexible global approach seek to accomplish.

The chart:

  • The chart shows the option-adjusted spread (OAS) of the Barclays Global Corporate Index, the Barclays Global High-Yield Corporate Index, the Barclays Emerging Markets Investment Grade Index and the Barclays Emerging Markets High Yield Index from August 2010 – August 2015.
  • As of August 31, 2015:
    • The OAS of the Barclays Global Corporate Index was 154 basis points, the highest since June 2013—amid the taper tantrum
    • The OAS of the Barclays Global High-Yield Corporate Index was 531 basis points, the highest since November 2012.
    • The OAS of the Barclays Emerging Markets Investment Grade Index was 228 basis points, the highest since August 2013—amid the taper tantrum
    • The OAS of the Barclays Emerging Markets High Yield Index was 733 basis points, the highest since April 2009—the depth of the financial crisis.

Definitions:

The Barclays Global Corporate Index is the corporate component of the Barclays Global Aggregate Index, which provides a broad-based measure of the global investment-grade fixed income markets. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The Barclays Global High-Yield Corporate Index is the corporate component of the Barclays Global High-Yield Index, which provides a broad-based measure of the global high-yield fixed income markets.

The Barclays Emerging Markets Investment Grade Index is the investment-grade component of the Barclays Emerging Markets Index, which includes USD-denominated debt from emerging markets in the following regions: Americas, Europe, Middle East, Africa, and Asia.

The Barclays Emerging Markets High Yield Index is the high yield component of the Barclays Emerging Markets Index, which includes USD-denominated debt from emerging markets in the following regions: Americas, Europe, Middle East, Africa, and Asia.

A basis point (bps) is one one-hundredth of one percent (1/100% or 0.01%).

A credit spread is the difference in yield between two different types of fixed income securities with similar maturities, where the spread is due to a difference in creditworthiness.

Developed markets refers to countries that have sound, well-established economies and are therefore thought to offer safer, more stable investment opportunities than developing markets.

Emerging markets are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.

An Option-Adjusted Spread (OAS) is a measure of risk that shows credit spreads with adjustments made to neutralize the impact of embedded options. A credit spread is the difference in yield between two different types of fixed income securities with similar maturities.

Taper tantrum refers to the financial markets' reactions, in May-August 2013, to the announcement by the Federal Reserve that it was planning to decrease, or "taper" its $70 bn per month bond buying program.


IMPORTANT INFORMATION:

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or investment advice.

Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

Commodities contain heightened risks that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Diversification does not assure a profit or protect against market loss.

Active Management does not ensure gains or protect against market declines.

Yields represent past performance and there is no guarantee they will continue to be paid.

This material is for information only and does not constitute an invitation to the public to invest in any funds, securities, strategies or other products. You should be aware that the investment opportunities described should normally be regarded as longer term investments and they may not be suitable for everyone. All investments involve risk, including possible loss of principal. The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Past performance is no guide to future returns and may not be repeated. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.

Please note that an investor cannot invest directly in an index. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data. Individual securities mentioned are intended as examples of portfolio holdings and are not intended as buy or sell recommendations. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

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Will China's official growth rate fall to 6 percent by the end of 2015?

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