Overweight US Corporate Bonds

The path of least resistance for corporate bond spreads is to tighten in the absence of a recession or a sustained and intense flight-to-quality episode.

Overweight US Corporate Bonds

I nvestors’ penchant for corporate bonds reflects excellent corporate balance sheet health and a wall of funds looking for yield. Our Corporate Health Monitor remains deep in “improving health territory”, despite showing some deterioration over the past couple of quarters.

What is somewhat more disconcerting is that both rating migrations and Moody’s 12-month trailing speculative grade default rate have increased in recent months. However, Moody’s expects that further upside in the default rate will be limited, rising to about 4%, before falling back below 3% by next May. This benign pattern is consistent with our own macro-based forecast of the default rate.

It is difficult to envisage a meaningful rise in the default rate anytime soon given low borrowing, an ample cash cushion, easing bank lending standards, and the terming out of debt.

As for ratings, downgrades have outpaced upgrades so far this year, but this appears to be a temporary blip, related to a flurry of downgrades in the banking sector. The difference between speculative-grade and investment-grade ratings changes has an excellent track record of leading the trend in overall ratings migration. This indicator has recently swung into improving territory, which historically has been correlated with periods of narrowing corporate spreads.

Bottom line: Corporate credit spreads, especially in the high-yield market, are attractive on a default-adjusted basis. Continue to overweight U.S. corporate bonds.

Print Friendly
About BCA Research

BCA Research is a world leading provider of independent investment research. Since 1949, the firm has provided its clients with leading-edge analysis and forecasts of the major financial markets, with clear and focused investment strategy recommendations and backed by countless proprietary models and leading indicators. Asset class coverage includes equities, fixed income, currencies, real estate, commodities and geopolitics. The firm provides its services to financial professionals across six continents, through a wide range of products, services, and meetings. BCA maintains a head office in Montreal, with local offices in New York, Los Angeles, London, Hong Kong, Sydney, and Buenos Aires. Not yet a client of BCA? Take a short trial to our research.