Category: Investment Grade Weekly

We hope this commentary finds you all safe and healthy. We wish we would be able to provide you more frequent commentary however things have been changing so rapidly that any update we could provide would have been deemed irrelevant by the time the ink dried on the page. We will seek to provide you with commentary weekly or as is relevant.

The investment grade credit market has just capped off one of the most volatile two week periods in the history of its existence.  The impact of a global pandemic as well as the Saudi-Russia oil standoff has weighed heavily on risk assets of all stripes, and although high quality investment grade typically behaves as a safe haven, even it has not been able to escape the grasp of panicked sellers.  Through the week ended March 20, the YTD gross total return on the Bloomberg Barclays US Corporate Index was -10.58%.  For context, the S&P 500 was down -28.33% over the same time period.  CAM does not provide intra-monthly performance for our portfolios but we are generally more conservatively positioned relative to the corporate index.  Recall that CAM has a significant structural underweight on BAA-rated credit by capping our exposure at 30% while the index has a BAA concentration of nearly 50%.  CAM also targets a minimum rating of A3 for its portfolio.  In a risk off panic, such as the one we have experienced as of late, it is BAA-rated debt that typically underperforms relative to A-rated debt and that has been consistent with what the market has experienced so far in 2020.  Year-to-date, A-rated credit has outperformed BAA-rated credit as spreads on the A-rated portion of the index have widened 270 basis points while BAA-rated credit has underperformed to the tune of 46 basis points, having widened 316 basis points thus far in 2020.  The AAA/AA portion of the corporate index has held up even better, having outperformed the BAA-rated portion of the index by 126 basis points year to date on a spread basis.  To be sure, a pandemic driven global recession is not bullish for investment grade credit, however, it is important to remember that we are talking about high quality investment grade rated companies.  This portion of a portfolio is designed to be the ballast that, over time, will reduce volatility and correlations with other asset classes in the context of a well-diversified portfolio.  A recession is not good for any asset class and there will be some investment grade companies that are more affected than others.  By and large the majority of these companies will see themselves through to the other side and the vast majority of companies will continue to pay interest and debts owed to bondholders.  It is also important to remember that, in the framework of a capital structure, bondholders are ahead of equity holders as it is the bondholders that have first claim on the assets of a company.  We are already seeing numerous companies change their behavior by suspending share buybacks and cutting dividends in order to protect their balance sheets so that they can continue to make good on their financial obligations that are not negotiable – payments to bondholders.

As far as our portfolio positioning is concerned, we are not infallible and we have some credits that have been impacted by the economic consequences of the pandemic.  We are closely monitoring these situations as we always do.  We are fortunate in that we have zero exposure to gaming, lodging, leisure or restaurants, as these have been particularly hard hit by the pandemic.  We have some exposure to the energy sector but we are materially underweight relative to the corporate index.  We have some exposure to airlines but no exposure to unsecured bonds – our only exposure to airlines is through bonds that are secured by the aircraft themselves.  Our high quality bias and our bottom up research process leaves us feeling positive about the positioning of our portfolio relative to the index and we are constantly monitoring the portfolio for opportunities to better position, which for us usually means to more conservatively position.

Market Recap                                                                                  

Remarkably, the investment grade primary market remains alive and well as the week of March 16-20 ended up as the third busiest of all time with 23 borrowers bringing over $62bln in new debt.  This flurry of issuance was important for the psyche of the market in our view as it once again proved that the investment grade market is never closed to high quality issuers.  This was true during the depths of the financial crisis and it is true now.  So why, may you ask, would issuers choose to print deals amid such volatility?  First, it is really just the prudent thing to do if a company has access – faced with an uncertain near term economic outlook; it makes sense to bolster the balance sheet.  Second, due to the drop in Treasuries, debt remains cheap.  Take Coca-Cola for example, which was able to issue 10yr debt with a coupon of 3.45% on Friday.  That is a very reasonable interest rate when viewed through a historical context.  It is also reasonable compensation for investors who are faced with declining yields throughout the world.

Flows have not been the friend for credit investors with long time horizons these past two weeks and the flows themselves have been an even bigger driver of performance than the pandemic in our view.  Outflows from IG credit for the week of March 12-18 were an eye-watering -42.7bln according to data compiled by Wells Fargo.  This represents the largest outflow on record and is nearly 5x larger than the previous record for a weekly outflow.  Investment grade credit is liquid, especially compared to the majority of other fixed income products, such as municipals, but it is not liquid enough to withstand an outflow of this magnitude without serious dislocation, and that is exactly what occurred over the past week.  Liquidity for investment grade was easily as bad as it has been since the financial crisis and quite possibly worse based on the opinion of our team at CAM.  To be clear, yes the pandemic will weigh on credit metrics for many IG companies, but the underperformance of the IG market over the past week was much more about flows than concerns about creditworthiness.  This was panic selling plain and simple.  If the market gets to a point where flows are positive or even neutral then the path of least resistance is tighter spreads.  The dislocation has created opportunity for committed investment grade buyers especially at the front end of the curve as you can now purchase the 5-6-7 year bonds of some issuers at yields that are greater than their bonds that mature at 10yrs and beyond.

The Federal Reserve continues to act aggressively and decisively as it announced support for numerous market segments on Monday morning.  Of particular interest to us is that the Fed will now be buying investment grade rated corporate bonds.  The Fed will operate a Primary Market Corporate Credit Facility and a Secondary Market Corporate Support Facility.  Through the Primary Facility the Fed will purchase IG rated corporate bonds with maturities of 4 years or less.  Through the Secondary Facility, the Fed will purchase IG rated corporate bonds maturing in 5 years or less and it will also be providing liquidity for fixed income ETFs which should go a long way to correcting some of the price discovery problems we saw in the IG market last week.  This package by the Fed had the immediate effect of driving IG credit spreads significantly tighter, but more importantly than that it gave the market some much needed confidence.  The next step to instilling some semblance of calm into the capital markets would be the passage of a substantial relief package by the Senate.  They failed to come to an agreement Sunday evening and for the second time Monday afternoon but we are hopeful that they will come to terms by the end of this week.

As we continue to navigate these turbulent times we wish the best for the health of you and your families.  Thank you for your continued interest.

This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.

Corporate credit spreads were wider across the board this week but lower Treasury rates were the bigger story and more than offset the move wider in spreads.  After closing the week prior at a spread of 96, the Bloomberg Barclays Corporate Index closed Thursday evening at a spread of 97, but spreads are weak and drifting wider as we go to print on Friday morning.  Global risk markets are skittish among renewed fears that coronavirus may not be adequately contained.  Frankly, we are a bit mystified at how easily markets dismissed virus fears to this point.  It is not so much the virus itself but the fact that the second largest economy in the world has been closed for business for the better part of a month.  This has serious consequences for growth across the globe due to the interconnected nature of the global economy.  Treasuries were volatile over the course of the past week.  The 10yr closed at 1.58% last Friday and it is wrapped around 1.45% as we go to print, coincident with its lowest levels of 2019.  Meanwhile, the 30yr Treasury fell as much as 7 basis points on Friday morning to an all-time low of 1.89%.

The primary market had a very solid week especially considering it was shortened by one day due to a market holiday on Monday.  Weekly issuance topped $35bln pushing the month-to-date total north of $86bln.  Year-to-date issuance is now closing in on $220bln which is ahead of 2019’s pace by more than +23% according to data compiled by Bloomberg.  Issuance is off to a strong start in 2020 but we would expect this pace to slow in the second half of the year as the presidential election approaches.

According to Wells Fargo, IG fund flows during the week of February 13-19 were +$7.4bln.  This marks one of the strongest starts to a year on record.  Year-to-date IG fund flows have now eclipsed $71bln.

Spreads for corporate credit were generally tighter on the week.  After closing the week prior at a spread of 102, the Bloomberg Barclays Corporate Index closed Thursday evening at a spread of 96.  The tone at mid-day Friday is mixed as risk markets continue to weigh the impact of coronavirus.  Treasuries were volatile over the course of the past week.  The 10yr closed at 1.51% last Friday which was its lowest level of the year.  The benchmark rate then closed as high as 1.65% this Wednesday and is now fluttering around 1.58% on Friday afternoon.

The primary market had a fair week as corporate borrowers issued over $21bln in new debt.   2020 issuance has eclipsed $154bln according to data compiled by Bloomberg.

According to Wells Fargo, IG fund flows during the week of January 30-February 5 were +$9.0bln making it the largest 5-week total for fund flows on record.  This brings year-to-date IG fund flows to over $36bln.  Both domestic and global investors continue to favor U.S. credit markets as one of the last bastions for reasonably safe yield.

Spreads drifted 2 basis points wider on the week with the OAS on the corporate index moving from 93 to 95.  Fears of a global health crisis drove Treasuries to 2020 lows and the 10yr is currently trading at 1.698% as we go to print, its lowest level of 2020.

It was another solid week for the primary market as over $25bln in new debt was priced.   January issuance has now topped $123bln which is up 46% relative to 2019’s pace according to data compiled by Bloomberg.  New deals of all stripes have been well oversubscribed and while there were still new issue concessions available they were quite slim, typically just a few basis points.

According to Wells Fargo, IG fund flows during the week of January 16-22 were +$4.8bln.  This brings year-to-date IG fund flows to over $20bln.  This is the third consecutive week of strong inflows into the IG credit market.

(Bloomberg) Delayed Disclosure of Biggest Corporate Bond Trades Stalls

• S. regulators have halted a plan to test whether delayed disclosure of corporate bond trades would boost market liquidity after a powerful group of investors, including Vanguard Group Inc., Citadel and AQR Capital Management, slammed the proposal.
• A Wall Street trade group informed its members late last year that the Financial Industry Regulatory Authority’s controversial plan had been put on hold, said two people familiar with the matter. The brokerage watchdog could still make changes and go forward after consulting with the Securities and Exchange Commission, another person said.
• Finra’s plan was to review the impact of giving traders two full days before having to reveal so-called block trades — the largest transactions. Some of the biggest money managers, such as Pacific Investment Management Co. and BlackRock Inc., have argued that a requirement that block trades be reported within 15 minutes has made it harder for banks to profit from facilitating buying and selling. That has prompted Wall Street securities firms to retrench, making it harder for buy-side participants to execute trades.
• Finra first proposed its study in April 2019 and gave the public until June 11 of last year to provide feedback. The regulator has said little about the test in the seven months since the comment period expired.
• Corporate bond trades are revealed through Finra’s Trade Reporting and Compliance Engine, better known as Trace. The regulator introduced the system in 2002 with the goal of increasing transparency, as most transactions have historically taken place over the phone between buyers and sellers.
• A common refrain among Wall Street banks is that rules passed in the wake of the 2008 financial crisis made it harder and more expensive for them to hold large inventories of corporate bonds. That has prompted banks to function mostly as intermediaries that link up buyers and sellers, rather than purchasing big blocks of bonds from investors and then unloading the debt over time for a profit.
• Vanguard disputes those claims. In its letter, the asset-management giant said there’s no proof that prompt disclosure of trades is hurting liquidity. But it is clear, according to Vanguard, that increased transparency lowers transaction costs. It called the proposed study “a harmful solution to an unsubstantiated problem.”

(Bloomberg) Investors Just Keep Pumping Cash Into Corporate Bond Funds

• Credit bond funds continue to rake in cash as investor appetite for risk remains voracious.
• Buyers pushed $4.2 billion into high-grade funds for the week ended Jan. 22, according to Refinitiv Lipper. That’s on top of last week’s $6.6 billion influx and a record $8.2 billion inflow from the prior reporting period.
• This month’s sum covering the first three weeks of the year — a whopping $19 billion — already exceeds last year’s full-month January inflow total by about $5 billion.
• Seemingly insatiable demand has kept the high-grade primary market hot as some new bond deals come in as much as seven times oversubscribed and secondary spreads stand at the tightest level since February 2018.

It was another busy week in the corporate credit markets; inflows remained robust, the new issue calendar continued to hum and the secondary market featured buyers grabbing for yield.  Risk markets have been incredibly resilient as they have shrugged off geopolitical turmoil and they seem to have little interest in impeachment or the upcoming presidential primaries and election.  The spread on the corporate index is one basis point tighter on the week, currently trading at 95.  The range in spreads on the index thus far in 2020 has been tight at just three basis points.

The primary market was busy again with more than $35bln in new debt coming to market on the heels of $60bln+ the week prior.  Demand was very strong as order books were well oversubscribed, even for companies with marginal credit metrics.  It is early in the year but so far new issue supply is 32% higher relative to last year, according to data compiled by Bloomberg.  Recall that CAM’s projection as well as the general consensus is calling for overall supply in 2020 to be down relative to 2019 especially on a net basis.  We expect that issuers will look to be quite active in the first half of the year and that issuance will be more subdued in the second half due to the uncertainty that typically accompanies a presidential election.  The consensus supply number for January is $120bln, according to data compiled by Bloomberg, so next week should be another solid week for issuance but will likely be somewhat lower than the previous two weeks due to earnings blackout periods.

According to Wells Fargo, IG fund flows during the week of January 9-15 were +$5.5bln.  This brings year-to-date IG fund flows to over $15.5bln, a strong start to the year.

(Bloomberg) That $1 Trillion BBB Powder Keg Worries Credit Investors Again

• Investors raised doubts about BBB debt in late 2018, when General Electric Co. was in crisis, its bonds tanked, and investors fretted about market turmoil from mass downgrades. Those fears proved misplaced last year, when investors stampeded into BBB notes and crushed risk premiums on the securities to around their lowest level since the financial crisis. Those narrow risk premiums are what worry at least some money managers.
• Because BBBs make up more than half the $8.4 trillion investment-grade corporate markets in both the U.S. and Europe, there’s that much more debt at risk of possibly falling to speculative grade. In 1993, BBBs were more like a quarter of the market.
• Signs of trouble for BBB companies have started brewing this year. Italian infrastructure company Atlantia SpA lost its last remaining investment-grade rating this week, and Boeing Co.’s biggest Max supplier, Spirit AeroSystems Holdings Inc., has also fallen into junk.
• Some money managers are focusing on finding bargains among BBB notes. Many of the largest BBB constituents gorged on debt to fund M&A, bringing their total obligations in 2018 to around $1 trillion, according to a Bloomberg analysis. Some of those companies have put debt reduction at the forefront, selling assets and cutting dividends to free up cash. That helped make GE, AT&T and AB InBev among 2019’s best corporate bond investments.

Another week has come and gone and corporate bonds continue to inch tighter into year end.  The OAS on the Bloomberg Barclays Corporate Index opened the week at 99 and closed at 95 on Thursday.  Spreads are now at their tightest levels of 2019 and the narrowest since February of 2018 when the OAS on the index closed as low as 85.  Price action in rates was relatively muted during the week amid low volumes but Treasuries are set to finish the week a few basis points higher.  The 10yr opened the week at 1.87% and is trading at 1.91% as we go to print.

As expected, the primary market during the week was as quiet as a church mouse.  December supply stands at a paltry $18.9bln according to data compiled by Bloomberg.  2019 issuance stands at $1,110bln which trails 2018 by 4%.  As we look ahead to 2020, we expect robust supply right of the gates in January but the street consensus for 2020 as a whole is that supply will be down 5% relative to 2019.  Further, net supply, which accounts for issuance less the 2020 maturity of outstanding bonds, will be down substantially from prior years.  If these forecasts come to fruition then the supply backdrop could lend technical support to credit spreads in 2020.  Supply, however, is merely one piece of the puzzle.

According to Wells Fargo, IG fund flows during the week of December 12-18 were +$0.85bln.  This brings YTD IG fund flows to +$295bln.  2019 flows are up over 11% relative to 2018.

The grind continues as the OAS on the Bloomberg Barclays Corporate Index breached 100 for the first time in 2019 with a 99 close on Thursday evening.  The index has not traded inside of 100 since March of 2018 and has averaged a spread of 127 over the past 5-years and 113 over the past 3-years.  Treasuries were again volatile on the week, especially Friday, which saw a range of 15 basis points on the 10yr Treasury.  However, as we type this during the late afternoon on Friday it appears that the 10yr is going to end the week almost entirely unchanged from the prior weeks close.

The primary market has entered year-end Holiday mode. Less than $4bln in new debt was brought to market during the week.   The first half of next week is the last chance for meaningful issuance in the month of December.  According to data compiled by Bloomberg, 2019 issuance stands at $1,110bln which trails 2018 by 4%.

According to Wells Fargo, IG fund flows during the week of December 5-11 were +$5.4bln.  This brings YTD IG fund flows to +$282bln.  2019 flows are up over 10% relative to 2018.

Credit spreads are set to finish the week generally unchanged but may be a touch wider in some spots when it is all said and done.  The spread on the Bloomberg Barclays Corporate Index opened the holiday shortened week at 105 and closed at 106 on Thursday.  There is positive sentiment in the markets on Friday morning amid China-US trade innuendo out of Washington.  For the second week in a row we have seen a relatively significant move in treasuries; last week it was higher rates and this week lower.  The 10yr Treasury closed the prior week at 1.94% and is now 1.83%, 11 basis points lower on the week as we go to print.

The primary market posted an impressive haul this week, especially considering the fact that the market was closed on Monday.  It was the second largest volume week of the year thanks to a big boost from AbbVie, which printed a $30bln deal that featured 10 different maturities.  With one deal pending this morning, weekly issuance will come in at the $50bln mark.  Oddly enough both the largest and second largest issuance weeks in 2019 have both come on holiday shortened weeks.  The largest volume week was the week of Labor Day when nearly $75bln of new debt was priced in just four days. According to data compiled by Bloomberg, 2019 issuance stands at $1,065bln which trails 2018 by -4.4%.

According to Wells Fargo, IG fund flows during the week of November 7-November 13 were +$2.8bln.  This brings YTD IG fund flows to +$252bln.  2019 flows are up 9.5% relative to 2018.

Bloomberg) AbbVie Propels High-Grade Issuance to Year’s Second-Biggest Week

• It’s the second-biggest week of the year for U.S. investment-grade issuance, which at about $50 billion in volume trails only the record-setting start to September.
  • AbbVie’s $30 billion deal on Tuesday clocked in as the year’s largest bond sale and the fourth-biggest ever, helping to establish this week’s second-place finish
    • Supply for the week stands at $49.4 billion as of Thursday with more deals potentially coming Friday given a shorter window to sell debt after Monday’s Veteran Day close
    • The first week of September saw $75 billion of high-grade bond sales, the most for any comparable period since records began in 1972
    • This week overtook the five days to May 9, when IBM and Bristol Myers brought $39 billion in acquisition-related supply in a 24-hour span

(Bloomberg) Here’s How KKR Might Just Pull Off the Biggest LBO in History

• One of the private equity industry’s titans called it a “stretch,” and it’s been dismissed as a pipe dream by a bevy of analysts.
• Yet interviews in recent days with debt-market specialists suggest that KKR & Co. could find a narrow path to finance what would be the biggest leveraged buyout in history: a potential take-private deal for pharmacy chain Walgreens Boots Alliance Inc. that analysts have estimated would need to be funded with at least $50 billion of debt.
• The challenge for any Walgreens suitor will be raising the necessary money via the markets of choice for private equity firms — junk-rated loans and bonds — which have become fragile after an unprecedented borrowing binge left investors with a hangover. Debt funds that financed more than $3.5 trillion of leveraged buyouts in the past decade have become pickier, leaving banks stuck holding more than $2 billion of unsold loans on their balance sheets as recently as last month.
• But a road map may be hidden in two other recent debt-fueled takeovers: Dell Technologies Inc.’s $67 billion takeover of EMC Corp. in 2016 and Charter Communications Inc.’s $78.7 billion acquisition of Time Warner Cable Inc. that same year.
• Junk-rated Dell and Charter both borrowed heavily in the investment-grade bond market by issuing secured debt. T-Mobile US Inc. is going down a similar route to help pay for its purchase of Sprint Corp.
• In Charter’s case, it pledged security to new and existing bonds issued by higher-rated Time Warner to ensure the debt remained investment-grade. Dell used a similar strategy when it bought investment-grade rated EMC. Walgreens’s debt could be segregated into two borrowing structures at a holding company level and an operating company portion, with investment-grade debt placed on the latter.
• In doing so, Dell and Charter won access to the most stable part of the corporate debt market, where investors are still buying heavily as an alternative to low or negative-yielding assets elsewhere. At the same time, they limited their reliance on leveraged finance markets, where sentiment can shift quickly and prove costly.
• Both companies did tap those markets, but with more manageable offerings. Bankers who asked not to be identified estimated that Walgreens would be able to raise between $10 billion and $20 billion of junk-rated debt to fund a buyout.
• Other market participants, who asked not to be named because they weren’t authorized to speak publicly, said KKR still might need to find a deep-pocketed third-party investor to help put more equity into the deal.
• Or it may seek to spin off a portion of Walgreens to lessen its financing needs. The company’s European operations could potentially bring in $18 billion to $20 billion, CreditSights analyst James Goldstein said in a phone interview.

Credit spreads were tighter during the week and are now at the tightest levels of 2019.  The spread on the Bloomberg Barclays Corporate Index closed at 105 on Thursday and there is a positive tone in the air on Friday morning which could lead to an even tighter close as we head into the long weekend –the bond market is closed on Monday in honor of Veteran’s Day.  The move in Treasuries during the week has more than overshadowed tighter credit spreads.  It has been a quick and violent move higher in rates.  As we go to print the 10yr Treasury is over 22 basis points higher on the week while the 30yr is 21 basis points higher.  Unpredictability in rate moves is the principal reason that we are “rate agnostic” at CAM and instead focus on credit risk while avoiding interest rate speculation by always positioning investor portfolios in intermediate maturities.

The primary market got a decent start to the month as $21.8bln in new debt came to market.  The pace should pick up substantially as soon as next week due to pending M&A funding from AbbVie which could total near $30bln. 2019 issuance has now passed the trillion dollar mark and it stands at $1,014bln which trails 2018 by -7%.

According to Wells Fargo, IG fund flows during the week of October 31-November 6 were +$3.2bln.  This brings YTD IG fund flows to +$249bln.  2019 flows are up 9.5% relative to 2018.

Bloomberg) Global Bond Sell-Off Persuades Some Investors to Buy the Dip

• Recent losses in Treasuries, which crescendoed Thursday into one of the worst days since Donald Trump was elected president, look like a buying opportunity for many investors who have a grim view of the economy’s prospects.
• And it appears some are pouncing, with traders cashing out bearish wagers and buy-the-dip buyers rushing in. The rekindled interest in the safety of bonds nudged yields on the 10-year, which had climbed to a three-month high of 1.97% on Thursday, down to as low as 1.89% in early European trading Friday before bouncing back to around 1.94%. European bonds rebounded after French and Belgian yields had climbed above 0% Thursday.
• Signs of progress in U.S.-China trade talks have thrashed bonds for days, and the two countries agreed Thursday to roll back tariffs on each other’s goods if a deal is reached. The Treasury market has seen a huge turnaround since August, when fears that global growth is slowing prompted the biggest monthly rally since 2008.

(Bloomberg) U.S. Says Phase-One China Deal Would Include Tariff Rollback

• The U.S. and China have agreed to roll back tariffs on each other’s goods in stages as negotiations continue over resolving the more than yearlong trade war, officials on both sides said.
• “In the past two weeks, top negotiators had serious, constructive discussions and agreed to remove the additional tariffs in phases as progress is made on the agreement,” China’s Ministry of Commerce spokesman Gao Feng said Thursday.
• White House economic adviser Larry Kudlow confirmed the advance in negotiations. “If there’s a phase one trade deal, there are going to be tariff agreements and concessions,” he told Bloomberg.
• An agreement to ratchet back tariffs would pave the way for a de-escalation in the trade war that’s cast a shadow over the world economy. China’s key demand since the start of negotiations has been the removal of punitive tariffs imposed by Trump, which by now apply to the majority of its exports to the U.S.
• “If China, U.S. reach a phase-one deal, both sides should roll back existing additional tariffs in the same proportion simultaneously based on the content of the agreement, which is an important condition for reaching the agreement,” Gao said Thursday.