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Corporate Perspective published on January 10, 2020

Q4 2019 Corporate Bond Market Outlook

Podcast Transcript

Good day, this is Laura Lake, Chief Investment Officer of Breckinridge Capital Advisors and I'm joined by Nick Elfner, our co-head of research. Today we’re going to discuss our investment outlook for the corporate bond market and we’ll take a brief look back at 2019 and then discuss valuations, fundamentals, and technicals as we kick off 2020. So, looking back over the fourth quarter and even all of 2019, it was clearly a strong period for investment grade corporate bonds. By the close of the quarter, the yield differential between the Bloomberg Barclays Investment Grade Corporate Index and duration-matched U.S. Treasuries had narrowed by over 20 basis points to an average spread of 93 basis points. And looking at all of 2019, the yield differential narrowed by an impressive 60 basis points.

Right, and coupled with a big move in Treasury yields lower, the IG corporate market generated its highest total return since 2009 at 14.5% per Barclays and as you noted at 93 basis points over, the IG corporate index spread is now back to February 2018 levels and it's approaching its cycle tights reached in January of that year.

The stars really aligned for investment grade corporates in 2019. Thinking back, we had three Fed rate cuts which really put a floor into risk assets. Also, net investment grade corporate supply was $350 billion, up 26% year-over-year per Barclays and bond fund flows were robust, we continue to see foreigners buy U.S. corporate bonds and other positive, earnings weren't as bad as feared when we started the year. As we turn our attention into 2020, it seems like expectations for the corporate bond market might need to be tempered a bit.

That’s right. We don't expect a repeat of the type of performance the IG market experienced in 2019. To us, 2020 looks like a year to earn your coupon or clip coupons so to speak. With spreads now below 100 basis points on average and range-bound interest rates, IG corporates should be able to generate modestly positive total and excess returns in 2020, but full valuations on the IG side do limit spread narrowing potential and pure beta performance. But still, we think bottom-up opportunities do remain in deleveraging stories.

And we really think that risk assets, including investment grade corporates, should continue to be supported by really accommodative central bank policies this year. Stimulative policy, low global interest rates should really sustain global investors reach for yield in U.S. corporate bonds. Profit growth also looks set to rebound in 2020. Earnings should expand as really key economies benefit from monetary stimulus and potentially fiscal stimulus.

Right. A risk to our investment thesis is a worsening of trade conflicts that negatively impacts growth, corporate profits, and that also can impact issuers deleveraging targets. I think the events of this past week remind us that geopolitics can also drive volatility in risk markets and finally the U.S. election is a key uncertainty in the second half of 2020 which could also impact IG corporate bond performance.

In terms of fundamentals and looking at our base case, it seems deleveraging should continue as we move into this year, debt use for mergers has really declined since peaking in 2017, and it's also notable that investment-grade issuer EBITDA margins bottomed in 2014 and have really steadily improved since. Really looking at current EBIDTA margins at nearly 30% are at their highest point since the post era crisis, per Barclays data. Looking at new supply, consensus estimates for this year indicate a dip in both gross and net supply, really based on slowing M&A activity, deleveraging goals from issuers, more overseas issuance, and really high U.S. amounts of debt maturities coming due.

Right. So, as it relates to environmental social governance, or ESG factors, we do find that IG issuers are devoting an increasing amount of attention to sustainability. Through our engagement discussions with corporate issuers, we are seeing steady improvements in ESG disclosures and an issuer's ability to articulate cohesive sustainability strategies and we do expect progress to continue in this area during the coming year.

Great. And that really wraps up our quarterly corporate market update and outlook for 2020. Thank you so much for joining us today.




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