Corporate Credit Market Begins to Catch Equity Markets

BOND STRATEGIST: The corporate bond market has been sceptical of the equity market's relentless march higher, but it appears that credit investors finally capitulated

Dave Sekera, CFA 16 April, 2013 | 10:24AM

For most of the year, the corporate bond market has been sceptical of the equity market's relentless march higher as credit spreads have been range-bound for most of the year and were slightly wider year to date through the first week of April. However, it appears credit investors finally capitulated, as credit spreads ripped tighter last Monday and Tuesday. However, while the S&P 500 has run up 11.4% year to date, seemingly impervious to any negative headlines, the Morningstar Corporate Bond index has only tightened 2 basis points this year, much less than one would expect as the S&P hits new highs. In fact, all of the tightening year to date occurred last Monday and Tuesday, when credit spreads tightened 5 basis points across the board.

We have heard two different explanations of why the credit markets finally decided to strengthen along with equities. The first story is that fund managers have been sitting on cash, waiting for better levels (wider spreads) to begin putting money to work. These investors finally relented and began to bid up bonds, given the continual inflow of funds and the increasing percentage of cash in their portfolios. This buying pressure was further exacerbated by dealers who were reportedly short credit and needed to cover their positions as bonds began to rise. The other story is that there were large buyers emerging from Asia who were selling yen-denominated assets and using the proceeds to rotate into US dollar-denominated assets, including corporate bonds. We don't know which narrative is accurate, but like any market chatter, there is probably a bit of truth to both.

We continue to view the corporate bond market as fairly valued at current levels, but will be analysing earnings and guidance closely this week and next for clues as to the direction of credit risk through the rest of this year.

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About Author

Dave Sekera, CFA  is a senior securities analyst with Morningstar.

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