The Bottom Line
- Corporate bond markets—both investment grade and high yield—are quite sanguine right now.
- Spreads—(i.e. the difference in yield between corporate bonds and similar maturity U.S. Treasuries) are fairly low1, suggesting little concern about economic conditions and the general state of corporate balance sheets.
- Some see this as peculiar, given that the total level of corporate debt has reached a new high for the current economic cycle.
- But that doesn’t take into account the relative quality of the debt that’s been issued in the wake of the financial crisis.
- Western Asset notes that a significant portion of new issuance has come from high-quality companies making high-quality acquisitions—and from companies with virtually no debt choosing to take advantage of low rates to fund future expansion.
- In other words, debt may be up, but not in a profligate manner
- Western also believes that there’s generally sufficient cash flow to pay down the current level of debt, putting little stress on balance sheets—a fundamental reason for current optimism in the sector.
- Yet that optimism also means that valuations are not cheap, making opportunities in credit markets harder to find than when spreads are wide—increasing the importance of careful analysis and credit selection in portfolio management.
1 Source: Bloomberg. As of April 7, 2017 the option-adjusted spread (OAS) of the Bloomberg Barclays U.S. Corporate Bond Index was 118 basis points versus a 20-year average of 154 basis points; and the option-adjusted spread (OAS) of the Bloomberg Barclays U.S. Corporate High Yield Index was 377 basis points versus a 20-year average of 489 basis points.