Investors are currently worried about corporate bonds. On the one hand performance has been pretty good, especially for the riskiest bonds. But therein lays the problem—highly indebted companies have not been punished and there appears to be way too much corporate debt at the moment. This is the Fed’s view and many market participants, but Goldman has shared another—that the amount of corporate debt in the economy is just fine and corporate balance sheets look healthy. The bank says US companies are in an “unusually healthy position this deep into a business cycle expansion”. Goldman notes that companies are spending a smaller share share of their cash flow on interest than they were a decade ago, and that they are earning more than they are spending.
FINSUM: The corporate debt situation is all about perspective. Things look better than in the last crisis, but anyway you slice it, the debt burden looks at least somewhat daunting.
The markets are gleeful right now. Stocks are up 25% since their bottom in December, and things on the economic and Fed fronts look rosy. However, Citi says investors need to get out of some assets before “rain spoils the picnic”. The bank is worried about the difference between asset prices and underlying economic conditions (when looking globally). Its biggest area of worry is in corporate bonds, which have seen spreads to investment grade narrow sharply, especially in high yields, which look overvalued. Investment grade debt is troubling too, as debt levels jumped by their biggest amount in 18 years over the last 4 months. Citi thinks companies are burning through way too much cash for the growth levels they are achieving.
FINSUM: So Citi thinks this is going to be a bond market reckoning (which would surely impact stocks too). That is different than the consensus, but perhaps a good way to view the situation.
One of the odd things about the recession fears since December is that spreads on junk bonds have not risen. Usually, junk bonds sell-off when there are recession fears, as they are the riskiest credits and likely to suffer the worst downturns. However, the opposite has happened in junk, with spreads to investment grade very tight. In fact, investors are picking up so little extra yield in junk bonds, that in many cases they are not even worth the risk. Spreads are tied for their narrowest since the Financial Crisis at just 60 basis points.
FINSUM: The last time spreads got this tight was last October, right before the market tanked. Warning sign.
The general understanding of markets is that bond investors are signaling that there is going to be a recession. Treasury yields have tumbled, and the Treasury yield curve has inverted, both signs of a coming downturn. However, the corporate bond market is sending a different signal, and it is worth paying attention to. The big sign of economic worry in the corporate bond markets is widening spreads between investment grade bonds and junk, but that is exactly the opposite of what is happening. The market is sanguine, and showing little of the concern that Treasury markets are. “Corporate spreads are extraordinarily narrow”, says Dan Fuss, vice chairman of Loomis Sayles.
FINSUM: This is a very good sign in our opinion. While it could turn out to be wrong, we do think this signals that Treasury investors may simply be overreacting.
It is time to get out high yield. The sector has been seeing heightened fears for months, and prices have performed so well in the first two months of the year, that there is little value left. High yields returned 6.4% in January and February after the market came to a virtual standstill at the end of 2018. Part of the reason for the outperformance is that investors are demanding less spread to Treasuries, a fact that has not carried over to the investment grade market.
FINSUM: The pendulum has swung too far, and investment grade bonds now appear a much better value than high yield.