US investment grade yields are at an eight-year high, after considerable moves higher year-to-date. With midterm election uncertainty in the rear view mirror, could now be an opportune time to add some exposure?
Growth is continuing at pace, especially in the US, where employment growth has surprised to the upside, wage growth is accelerating and non-manufacturing survey data remains at high levels. Softer data in Europe suggests divergence in global growth, but for now, most economies in the region are still expanding. On the political front, the US midterm election passed without incident and was consistent with expectations. The focus should now return to credit fundamentals, which look robust for now: third-quarter earnings seem healthy, as shown by growth in earnings per share of 27% among S&P 500 companies, and revenue growth of 9%. In Europe, the picture is less robust, but still positive: 10% and 6% in earnings and revenue growth respectively. Caution is required, however, as there is a growing belief that US earnings may have peaked, under pressure from a stronger dollar, rising rates and higher wages. Trade tariffs and legislation have also put pressure on some sectors, such as the automotive sector. With that said, the near-term outlook for credit is generally good, especially given increasingly compelling valuations.
US investment grade corporate bond yields now look attractive relative to history, reaching an eight-year high this month at 4.3% on a broad index level. In Europe, yields of 1.1% are the highest since March 2016. Spreads have also backed up this year, despite rising core rates, with both US and European markets widening by 22 basis points (bps) and 40bps respectively. Given that fundamentals appear to be stable, this could represent an opportune time to invest. Following completion of recent bank stress tests, which did not highlight anything concerning, European bank capital is one area where valuations look attractive: Contingent convertible (CoCo) spreads have widened by 85bps year-to-date, to 3.91% (data as of 6 November).
Corporate front-end yields are now at levels not seen since 2009
Source: Barclays Live; data as of 6 November 2018.