High-Yield Bonds Rally as Spreads Near Multiyear Highs
While last week ended on a sour note after Apple (AA-, negative) reported weaker-than-expected earnings, the S&P 500 had surged higher before that and, even after accounting for the pullback Friday, rose 2.42% for the week. While there were some disappointments in the technology sector as a few highfliers failed to meet the Street's lofty growth expectations, reported earnings growth has generally been robust, and economic growth remains relatively strong.
In the corporate bond market, investment-grade bonds were unable to participate in the rally; investors were unwilling to pay up for investment-grade corporate bonds as Treasury prices were plunging. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade market) widened 1 basis point and ended the week at +122. However, in the junk bond market, with its wider credit spreads (closing in on two-year highs) and shorter durations, the risk-on atmosphere created by rising stock prices led investors to bid up prices and push spreads tighter. The BofA Merrill Lynch High Yield Master Index tightened 13 basis points to end the week at +372. As the equity market rebounded, the risk-on atmosphere reopened the window to the new issue market and corporate bond issuers returned to the market place. Now that most companies have reported third-quarter results and the holidays will arrive sooner rather than later, we expect that the next few weeks will be busy in the new issue market as CFOs look to complete their capital market activities before the new issue window closes toward the end of the year.
With investors rushing back into risk assets, the U.S. Treasury market gave back the price gains it made the prior week, when investors fled to the safety of bonds as equity prices plummeted. By the end of the week, the yield on the 2-year rose 9 basis points to 2.90%, the 5-year increased 12 basis points to 3.03%, the 10-year rose 13 basis points to 3.21%, and the 30-year increased 14 basis points to 3.45%.
The S&P 500 was not the only index to regain some of its recent losses. In Europe, Germany's DAX rose 2.84%, France's CAC increased 2.71%, Spain's IBEX rose 3.01%, and Italy's MIB surged 3.78%. However, even after these strong weekly gains, the main European indexes remain in the red year to date as the DAX, CAC, IBEX, and MIB have posted losses of 13.52%, 6.74%, 13.62%, and 14.81%. In the European sovereign debt market, investors drove up the price of Italy's 10-year bond, which pushed the yield down 13 basis points to 3.32%. The yield has risen 130 basis points thus far this year, starting in earnest after the Italian government disclosed its original 2019 budget, which would have breached the European Union's limit. The yield has since stabilized after the Italian government signaled that it may revise its 2019 budget in order to reduce its forecast deficit.
Recent Morningstar Credit Ratings Research
Last week, Morningstar Credit Ratings' basic materials team published its quarterly Corporate Credit Spread Chartbook. In this report, Sean Sexton, MCR's senior basic materials analyst, noted that the chemicals subsector is stable, since most end markets for these issuers have remained relatively steady over the past several quarters. For metal producers, steel tariffs have had a positive impact on steel prices and margins, thereby increasing cash flows for issuers in this sector. Steel Dynamics and U.S. Steel have positive outlooks that reflect these strong cash flows. In mining, relatively robust prices for iron ore, metallurgical coal, and copper continued through the first three quarters of 2018. We have positive outlooks on Freeport-McMoRan, Southern Copper, Teck Resources, and Vale, which are a result of these prices and their corresponding cash flow impacts.
As third-quarter earnings season continues, we published credit notes on AbbVie (BBB+, stable), Amgen (A, stable), Allergan (BBB, stable), BP (A-, stable), Eastman Chemical (BBB, stable), Hanesbrands (BBB-, stable), HCA Healthcare (BB+, stable), Marathon Petroleum (BBB, stable), Teva (BB, stable), National Retail Properties (BBB+, stable), and Weatherford International (B-, negative).
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