Investment-grade corporate credit spreads have continued to tighten on the back of strong market technicals. A dearth of long duration supply has been met by continued strong demand from traditional money managers, pension funds, and foreign demand from both Asia and Europe.
All-in yields have reached levels not seen since the Global Financial Crisis while issuer balance sheets are in a much healthier position. As the ratio of corporate index yields to the S&P 500 dividend yield reached a peak of 4.62x, the incentive for pension funds to rotate out of equities into fixed income remains attractive. Demand for duration has been met by a shrinking volume of longer dated corporate debt supply, with year-to-date 30-year corporate bond issuance down 17 percent versus last year. Corporate bond issuers, anticipating Fed rate cuts and lower coupons in 2024, remain hesitant to lock in higher rates for 20+ years. The lack of longer duration corporates has resulted in a historically flat 10 /30-year credit curve, which will likely persist throughout the fourth quarter but then steepen as fundamentals worsen or if interest rates fall. As a result, we believe investors should consider taking profits from credit-curve flattening positions and start shifting towards curve steepening trades.
Although technicals and yields remains attractive, investment-grade corporate credit spreads as a percentage of all-in yield hit a 15-year low of 19.5 percent, a historically low measure of investor concerns around credit risk. As the economy slows, however, we believe credit fundamentals will continue to deteriorate. This will lead to increased dispersion of performance within investment-grade corporates, highlighting the need for careful sector selection. Utilities, a highly regulated industry, offers both historically attractive yields and duration profile in the form of 30-year first mortgage bonds. We continue to favor large, high-quality financials over industrials given historic spread relationships: Financials relative to industrials peaked in March at around 50 basis points, and ended the third quarter at 48 basis points. While this relationship is in part skewed by continued stress in regional banks, which we continue to avoid, this relationship should normalize and compress. Supply of bank-issued preferred stock ($1,000 par) will remain low but recent 7–8 percent new issue fixed coupons are at historically attractive levels for strong issuers.
Despite continued rate volatility and rising geopolitical concerns, we expect the attractiveness of investment-grade corporates from a yield and duration perspective will remain intact and provide support to credit spreads going into year end.
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This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.
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