A Finger in the Dike

There is a lot to like about the corporate credit market at this time. Fundamentals, technicals and valuation are all supportive, and unless we spring a hole in the dike all should be fine for a while longer.

As far as fundamentals go, 1Q17 earnings for investment grade debt issuers are robust with the help of good bank and energy earnings. Even high corporate leverage may be moderating. Technicals are favorable, with a large pool of buyers for a constant stream of corporate debt offerings. In addition, very low rates in Europe and Japan certainly help the bid for U.S. corporates. If you are looking for income in a yield starved fixed income universe, U.S. corporate credit is a good place to shop. Finally, valuations have been on a winning streak since the sell-off in 1Q16. The corporate market has tightened close to 100 basis points on an OAS basis since its peak and is now close to the tights of the summer of 2014.

But recent events have us wondering if there is a leak in the dike – that is, is the corporate credit rally coming to an end? Last week Janet Yellen told us that “slowing growth during the first quarter is likely to be transitory,” and this may well be true. However, we have also seen a few months of weaker auto sales, an uptick in credit losses at some credit card issuers, slow bank loan growth and recent weakness in commodity prices. Even economic surprises appear to be turning negative.

Bloomberg U.S. Corporate Bond Index – Option Adjusted Spread (OAS)

That said, we do not think the dike is about to burst and flood the lowlands. The trajectory of faster GDP growth in the world is well established, and U.S. credit market fundamentals, technicals and valuations do not appear to be turning over. We do recognize this credit cycle is getting old, spread tightening is losing vigor and there are fewer opportunities for gains and yield. Though we are all still safe and dry behind the dike, as the cycle gets older it is a good time to keep an eye on any small holes in case they begin to get larger.”

Source: Bloomberg, The Federal Reserve, Barclays