Corporate credit markets were mixed this week as geopolitical tensions on the Korean peninsula receded and uncertainty surrounding domestic politics and policy escalated. High yield bond prices moved slightly higher on the week and recovered part of last week’s decline.1 Returns on senior secured loans declined approximately 0.09% for the week ended August 17.2 After providing their strongest monthly return of 0.78% in July 2017, senior secured loans are now generating mild losses of approximately 0.15% month to date.2 With yields on the 10-year U.S. Treasury note at approximately 2.18% and 43 basis points off their March 2017 high, weekly fund flows into senior secured loans since June have generally been only mildly positive.3,4 Relative to other fixed income asset classes, however, we believe both senior secured loans and high yield bonds remain attractive as investors continued to seek areas of the market that offer incremental yield. Despite having declined approximately 30 basis points year to date, for example, high yield bonds and senior secured loans still provide yields of approximately 5.73% and 6.00%, respectively, and remain among the higher-yielding areas of the fixed income market.5,6,4 Year to date, senior secured loans and high yield bonds have provided total returns of approximately 2.6% and 5.5%, respectively.1,2 Across both asset classes, year-to-date returns on CCC rated securities have outpaced those on BB rated loans and bonds.7,8
Based on the minutes released this week of the FOMC’s July meeting, U.S. Federal Reserve officials seemed confident the time to begin reducing its balance sheet was “relatively soon.”9 Some members were ready for the Fed to announce its asset reduction program at the July meeting.9 However, policymakers both at the July meeting and since appear to have little consensus in their outlook for monetary policy. While the Fed remains on a path toward gradually normalizing the federal funds rate, the minutes noted that the recent decline in inflation led some policymakers to believe the Fed “could afford to be patient under current circumstances.”9 Investors interpreted the minutes as dovish and grew more skeptical that the Fed would act again this year. The implied probability of a December rate hike fell from 43.8% on Tuesday to 30.2% on Thursday.10 Perhaps in an effort to combat investors’ skepticism that the Fed might raise rates again this year, William Dudley, Vice Chair of the FOMC and President of the Federal Reserve Bank of New York, noted in an Associated Press interview this week that he “would be in favor of doing another rate hike later this year” if economic conditions evolve in line with his expectations.11 With a relatively light economic calendar next week, all eyes will turn to the Economic Policy Symposium that begins in Jackson Hole, WY, on August 24 for further clues about the direction of monetary policy in the remainder of 2017.
Prime sales report
Following last week’s disappointing inflation and productivity reports, the economic data released this week was considerably stronger, with retail sales figures leading the way. According to the Commerce Department, U.S. retail sales in July advanced 0.6% on a month-to-month basis, the highest monthly increase since December 2016, and 4.2% from one year earlier.12 In the same report, retail sales data for May and June 2017 also was revised upward.12 July’s retail sales data featured widespread gains across industries, and was prodded along by sales during Amazon Prime Day that began on July 10.12,13 Retail sales are an important data point both because consumption remains nearly 70% of U.S. gross domestic product and because they represented a solid advance in so-called “hard” data, which has generally lagged consumer and business sentiment for much of the year.14,15 To this end, consumer confidence also showed continued strength in August. According to the University of Michigan Surveys of Consumers, consumer confidence in the first half of August rose to its highest level since January 2017.16 In the survey, consumers noted a positive outlook on the overall economy as well as their own personal financial prospects.16
Chart of the week: Positive surprises, negative returns
- We saw volatility spike last week as markets faced a broad sell-off amid escalating tensions surrounding North Korea.17 However, even this extraordinary geopolitical situation caused only a brief sell-off before equity markets recovered much of last week’s losses in the first half of this week.18
- Though equity markets have generally continued to move upward in 2017, one potential cautionary note has emerged in recent weeks. Specifically, this earnings season investors are no longer rewarding companies right after they announce a positive earnings surprise.19
- As the chart highlights, immediately after companies in the S&P 500 reported a positive earnings surprise for the second quarter of 2017, the company’s stock price decreased 0.3% on average from the two days before the company reported results.19
- This 30 basis point decline is well below the 5-year average increase of 1.4% that a company’s stock price has experienced after reporting a positive earnings surprise.19
- Although it can be a dangerous practice to read too much into stocks’ short-term price swings, one explanation for the change could simply be that in today’s market, investors have become harder to impress. Heightened equity valuations today suggest there may be a limit to how high equity markets can continue to rise.
1 Bank of America Merrill Lynch U.S. High Yield Master II Index.
2 Credit Suisse Leveraged Loan Index.
3 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
4 J.P. Morgan High-Yield and Leveraged Loan Morning Intelligence, Friday, Aug 18. Fund flows based on data from Thomson Reuters.
5 Yield-to-worst on the Bank of America Merrill Lynch U.S. High Yield Master II Index.
6 Yield to 3-year takeout on the Credit Suisse Leveraged Loan Index.
7 Bank of America Merrill Lynch U.S. High Yield CCC & Lower Rated Index; Bank of America Merrill Lynch U.S. High Yield BB rated Index.
8 CCC and BB rated components of the Credit Suisse Leveraged Loan Index.
9 Federal Reserve, http://bit.ly/2wQAMtE.
10 Bloomberg World Interest Rate Probability.
11 Reuters, http://reut.rs/2x0q9DJ.
12 Census.gov, http://bit.ly/Y4FaTF.
13 MarketWatch, http://on.mktw.net/2uKoLV3.
14 Federal Reserve Bank of St. Louis, http://bit.ly/2x8sf4B.
15 FactSet, http://bit.ly/2uNDoej.
16 University of Michigan Surveys of Consumers, http://bit.ly/1gDEQwe.
17 Chicago Board Options Exchange, http://bit.ly/2ncqQ9l.
18 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
19 Fact Set, S&P 500 Companies See Worst Price Reaction to Positive EPS Surprises since Q2 2011, http://bit.ly/2x8a4Mq.
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.