Corporate credit ended the quarter stronger, adding to September’s gains. High yield bonds trended higher throughout the week on the back of ongoing central bank accommodation and a rise in oil prices.1,2 High yield bonds provided returns of 0.3% in the week ended September 29, putting the asset class on track for its eighth consecutive monthly gain and a third quarter return of approximately 5.3%.1 Senior secured loans provided returns of approximately 0.2% in the week ended September 29, as the asset class is poised to deliver its seventh consecutive positive monthly return.3 Month to date, high yield bonds and senior secured loans have returned approximately 0.5% and 0.8%, respectively.1,3 Flows into both asset classes were decisively positive this week, with high yield bond mutual funds seeing more than $2 billion in inflows during the week ended September 28, recouping a portion of the outflows sustained in the two weeks leading up to the Federal Open Market Committee (FOMC) policy meeting.4 At $481 million, inflows into bank loan mutual funds were the highest since April 2015, and have now recorded their ninth consecutive weekly inflow.4 After posting nine consecutive quarterly outflows, flows into bank loan mutual funds turned positive in the third quarter to the tune of $2.2 billion.4 Year to date, senior secured loans are providing returns of approximately 7.4%.3 By comparison, high yield bonds and the S&P 500 have returned 15.2% and 7.0%, respectively, over the same period.1,5
On Wednesday, OPEC members reached an agreement in principle to a modest production cut.6 Although details were largely left to its next meeting in November, under the tentative proposal OPEC would collectively cut between 200,000 and 700,000 barrels per day from current production levels. If reached, the deal would cut output to between 32.5 million and 33 million barrels per day, from the 33.2 million barrels per day the cartel produced in August.6 While a formal agreement to curb output is far from certain, and skepticism remains over what effect any such deal might have on global supply, the deal could signal the re-emergence of an OPEC willing to manage oil supply in support of more stable oil prices. Although news of the tentative agreement boosted the price of oil to $48 per barrel, it was not enough to break out of the $40–$50 per barrel range it has traded in since early July.2 With rising oil prices as a backdrop, energy credit trended higher this week, continuing a rally that began last February. Year to date, high yield energy bonds and senior secured energy loans are providing returns of 30.3% and 21.8%, respectively.7,8 Amid a rise in oil prices, energy credit has seen significant yield compression. High yield energy bonds currently yield approximately 8.0%, down from nearly 21% in mid-February.9 Senior secured energy loans currently yield approximately 15.7%, down from over 26% in mid-February.10
Despite rising oil prices and a slight uptick in inflation, U.S. government bond yields turned lower this week as concerns over Deutsche Bank’s capital position caused investors to seek out the relative safety of global sovereign bonds at the expense of equities.11 The yield on the U.S. 10-year Treasury note had slipped to 1.57% by Friday despite a rise in U.S. consumer confidence, an upward revision to the estimate of second-quarter U.S. GDP, and a slight rise in the annual rate of core inflation.12,13,14 On Friday, the Commerce Department said the PCE Index, the U.S. Federal Reserve’s preferred measure of inflation, increased 1% in the 12 months ended August, with the annual rate of core inflation rising to 1.7%.11,14 With the U.S. Fed still signaling its intention to hike interest rates in 2016, federal-fund futures are currently placing a 56% chance of a rate hike by year-end, up from 50% at the beginning of the week.15 Next week investors turn their attention to October’s nonfarm payrolls report, which could do much to influence the narrative coming out of the next FOMC policy-setting meeting in November.
Chart of the week: Moving together
- Traditionally, many investors believed that a portfolio composed of 60% equities and 40% bonds provided sufficient diversification. In recent years, however, correlations across stocks and bonds have increased significantly.16
- Today, a wide range of asset classes – emerging market equities, emerging market corporate bonds, emerging market government bonds, U.S. Treasuries and U.S. high yield bonds among them – are all more correlated to U.S. stocks than they were in the past.1
- Both prior to and since the financial crisis, traditional bonds have not served as a source of significant diversification.
- As the chart above highlights, a portfolio with a 70% allocation to bonds and just 30% to stocks has produced nearly the same correlation to the S&P 500 Index as a more balanced portfolio of 60% stocks and 40% bonds since 1998.17
1 Bank of America Merrill Lynch High Yield Master II Index.
2 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
3 Credit Suisse Leveraged Loan Index.
4 Thomson Reuters Lipper.
5 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
6 Reuters, http://reut.rs/2dCzhIY.
7 Bank of America Merrill Lynch High Yield Energy Index.
8 Credit Suisse Leveraged Loan Index (energy component).
9 Bank of America Merrill Lynch High Yield Energy Index, yield to worst.
10 Credit Suisse Leveraged Loan Index (energy component), yield to a three-year maturity.
11 MarketWatch, http://on.mktw.net/2dcKiiq.
12 The Conference Board, http://bit.ly/1eu7yyH.
13 U.S. Department of Commerce, http://bit.ly/1eZ44Hx.
14 U.S. Department of Commerce, http://bit.ly/2d1o6G9.
15 Bloomberg based on CME data.
16 International Monetary Fund, Global Financial Stability Report, April 2015.
17 Bloomberg and FS Investments.
The Alternative Thinking Week in Review market commentary and any accompanying data (“Market Commentary”) is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The Market Commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such Market Commentary. The Market Commentary should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the Market Commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.