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Written by Kevin Flanagan
As the money and bond markets continue their Fed surveillance saga, there is one constant we’ve been emphasizing for the fixed income landscape: a new interest rate regime. An integral aspect of this investment preparation is… And that despite what the Fed may or may not do, interest rates appear to be on track to stay higher for longer.
Against this backdrop, investors have been trying to decide where they should allocate money in the fixed income world, specifically within the US. Typically, one can divide the bond market into two distinct sectors: interest-sensitive and credit-sensitive. I’ve spent a significant amount of time in recent blog posts and podcasts on the interest rate sensitive side of the equation, so I think it would be wise to address trends in US credit.
Investment Grade Spreads (RS) vs. High Yield Spreads (LS)
One key metric in measuring the relative value of US corporate bonds is to look at spread relationships when compared to Treasury securities. These spreads can help determine where current corporate bond yields might be in relation to historical levels. This analysis applies to both the investment grade (IG) and high yield (HY) worlds. For reference, a narrow spread is often seen as a sign that companies may lean towards being expensive, while a wider spread is seen as the opposite, or relatively cheap.
Throughout much of this year, there has been a feeling among investors that US corporate bonds appear to be more expensive on the expensive side of the ledger due to the fact that both IG and HY spreads have been visibly narrowing since late October. To provide some perspective, IG spreads are down more than 40 basis points (bps) while HY spreads are down about 140 bps, as of this writing. Their current levels of 87 basis points and 300 basis points place them at the lower end of historical ranges.
This is where things get interesting. Listening to some of the current accounts on the subject, one might be forgiven for thinking that the current readings are an unusual development. However, as the chart above shows, IG and HY spreads are definitely not in uncharted territory. In fact, there have been various periods in the past when companies were trading at these levels, and in some cases, even lower.
Although I would be the first to admit that US credit, based on current spread levels, is not necessarily cheap, the resilient economy and fairly favorable fundamentals suggest it is not necessarily expensive either. In fact, using history as our guide, as long as the economy does not fall off a cliff at any point in the coming months, IG and HY spreads can continue to trade in their current ranges, but we emphasize a quality checking approach. In fact, if the fundamental backdrop could be maintained, one would likely argue that the observed re-widening of spreads could be viewed as a buying opportunity, as seen in pre-Covid trading.
Conclusion
For investors looking to allocate to US credit, here are two quality-vetted solutions to consider:
- WisdomTree US Short-Term Corporate Bond Fund (SFIG): A Way to Benefit from an Inverted Yield Curve and the Potential for Fed Rate Lowering
- WisdomTree US High Yield Corporate Bond Fund (WFHY): Additional fundamental solution that aligns favorable fundamentals with income needs
Important risks related to this substance
There are risks associated with investing, including the potential loss of principal. Fixed income investments are subject to interest rate risk; Their value will usually decline as interest rates rise. Fixed income investments are also subject to credit risk, which is the risk that a bond issuer will fail to make interest and principal payments in a timely manner or that negative perceptions of the issuer’s ability to make those payments will cause the price of that bond to decline. . While the Fund attempts to limit exposure to credit and counterparties, the value of an investment in the Fund may change quickly and without notice in response to issuer or counterparty defaults and changes in credit ratings of the Fund’s portfolio investments. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
Kevin Flanagan, Head of Fixed Income Strategy
As part of WisdomTree’s Investment Strategy group, Kevin serves as Head of Fixed Income Strategy. In this role, he contributes to the asset allocation team, writes fixed income content, travels with the sales team, holds client-facing meetings and provides expertise on WisdomTree’s existing and future bond ETFs. Additionally, Kevin works closely with the fixed income team. Prior to joining WisdomTree, Kevin spent 30 years at Morgan Stanley, where he was a managing director and head of fixed income strategies for wealth management. He was responsible for tactical and strategic recommendations and created asset allocation models for fixed income securities. He was a contributor to Morgan Stanley Wealth Management’s Global Investment Committee, the lead author of Morgan Stanley Wealth Management’s monthly and weekly fixed income publications, and collaborated with the firm’s research and advisory group divisions to build asset allocation models for ETFs and fund managers. Kevin holds an MBA from Pace University’s Lubin Graduate School of Business and a bachelor’s degree in Finance from Fairfield University.
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