Spread sectors: The beat goes on

Written by: Global Thought Leadership | December 06, 2019

Chart courtesy of Western Asset. Source: Bloomberg Barclays, J.P. Morgan, S&P Global Market Intelligence, a division of S&P Global Inc, Western Asset, as of 11/15/2019. ¹S&P/LSTA Performing Loans Index excess return vs. 3-Month LIBOR. See definitions below. 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

  • Many fixed income spread sectors have seen strong returns so far this year, outperforming government bonds in general.
  • The outperformance was notable in U.S. and UK corporate debt, but especially striking in the European and U.S. high-yield sectors.
  • Much of the good news can be attributed to the general turn by central banks toward greater accommodation, which helped dispel lingering worries about riskier sectors.
  • Looking ahead, Western Asset CIO Ken Leech believes the U.S. economy will again grow at a moderate pace. 
  • Global growth will likely be slow—and inflation subdued—but that also means central banks are unlikely to tighten policy for a very extended period.   
  • That's a backdrop that could support further outperformance of spread sectors next year—but given the scope of the 2019 rally, expectations for next year should be tempered.

Definitions:

A Commercial Mortgage-Backed Securities (CMBS) is a type of mortgage-backed security that is secured by the loan on a commercial property.

A contingent convertible bond (CoCo), also known as an enhanced capital note (ECN) is a fixed-income instrument that is convertible into equity if a pre-specified trigger event occurs.

Emerging markets (EM) 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.

High yield, or below-investment grade bonds are those with a credit quality rating of BB or below.

Investment-grade (IG) bonds are those rated Aaa, Aa, A and Baa by Moody’s Investors Service and AAA, AA, A and BBB by Standard & Poor’s Ratings Service, or that have an equivalent rating by a nationally recognized statistical rating organization or are determined by the manager to be of equivalent quality.

The London Interbank Offered Rate (LIBOR) is the interest rate determined daily by a specific group of London banks for deposits of certain stated maturities.  LIBOR is used as a base index for setting rates of some adjustable rate financial instruments, including Adjustable Rate Mortgages (ARMs).

A Mortgage-Backed Security (MBS) is a type of asset-backed security that is secured by a mortgage or collection of mortgages.

Standard & Poor's (S&P) is an American financial services company that publishes financial research and analysis on stocks and bonds and is also known for its stock market indices such as the U.S.-based S&P 500.

The S&P/LSTA U.S. Leveraged Loan 100 Index, also called the S&P/LSTA Performing Loans Index is designed to reflect the performance of the largest facilities in the leveraged loan market.

Spread sectors refers to sectors of the bond market, such as taxable bonds that are not Treasury securities, and includes securities such as agency securities, asset-backed securities, corporate bonds, high-yield bonds and mortgage-backed securities.

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.

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Outperformance does not imply positive results.

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

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

Asset-backed, mortgage-backed or mortgage related securities are subject to additional risks such as prepayment and extension risks.