Corporate credit prices rose this week alongside another record high for U.S. equities, optimism surrounding the Republican-led tax plan and stable corporate earnings.1 High yield bonds returned approximately 0.23% in the week ended October 19, as a stronger backdrop for energy and light new issuance volumes overcame a modest outflow from high yield bond mutual funds.2,3,4,5 Month to date, high yield bonds have returned approximately 0.40%, with the energy and metals and mining sectors continuing to outperform the broader benchmark.2,3,6 High yield bond mutual funds experienced outflows of approximately $450 million during the week ended October 18, snapping a four-week run of inflows totaling nearly $3 billion over that span.5 Senior secured loan prices also ticked higher this week alongside a rise in long-term Treasury yields and a relatively light new issue calendar.4,7,8 Month to date, senior secured loans are now providing returns of approximately 0.54%, bringing the asset class’s year-to-date total return to 3.60%.7 For perspective, U.S. 10-year Treasury notes and investment grade bonds are providing month-to-date returns of approximately 0.17% and 0.46%, respectively.9,10
Energy was in focus this week, with geopolitical risks boosting the price of oil amid rising tensions in Iraq. Iraqi Kurdistan usually exports nearly 600,000 barrels of oil a day, and with Iraqi forces now in control of some Kurdish oil fields, some of that supply has been reduced.11 Oil prices also rose this week on the possibility that the U.S. could impose fresh sanctions on Iran, thereby limiting the country’s oil exporting capacity.12 The potential reduction to global supply and a 5.73 million-barrel decline in U.S. oil supplies combined to keep oil prices near a six-month high and provided a stronger backdrop for energy credit.13,14 High yield energy bonds and energy senior secured loans both outperformed the broader benchmark indexes this week and have returned approximately 0.53% and 1.09%, respectively, in October and 6.07% and 4.97%, respectively, in 2017.3,15 Other energy benchmarks continue to underperform, however. The Alerian MLP Index and S&P 500 Energy Index have returned -3.07% and -1.11%, respectively, in October and -8.57% and -7.67%, respectively, in 2017.16,17
U.S. equities have been steadily climbing in recent weeks, hitting fresh records on Friday after the Senate passed a budget blueprint late Thursday in a move that is seen as clearing the next hurdle for tax reform.18 Although supported by generally solid corporate earnings, recent gains have also made stocks relatively more expensive by some measures, with the S&P 500 now trading at approximately 17.5 times forward earnings.19 This compares to 16.8 times forward earnings as of December 31, 2016 and 14.3 times forward earnings as of December 31, 2007.19 Meanwhile, U.S. government bond yields have risen in recent weeks amid growing expectations that the U.S. Federal Reserve will raise interest rates once more by year’s end and the potential that Fed Chair Yellen could be replaced at the end of her term by someone with a more hawkish stance on monetary policy.20 This week, U.S. Treasury yields rose across the curve, with the U.S. 10-year note yield rising to a three-month high and the yield curve flattening to a year-to-date low.8,21 Amid a generally light macroeconomic calendar, the next logical catalyst for Treasury prices is likely to be President Trump’s decision on the next Fed chair, which is expected to come before he leaves for a trip to Asia on November 3.20
Chart of the week: Sentiment on stock prices riding high
- As equity markets reached another all-time high this week, investor sentiment shows signs of continued momentum.22 Domestic stock prices have been supported recently by expectations for continued slow, but steady, economic growth in the U.S., an improving macro outlook within the energy markets, and optimism surrounding the prospects for tax reform late this year or early next.23
- According to an October 2017 University of Michigan survey, investors expect the good times to continue into next year.24
- Approximately 65% of investors surveyed in the University of Michigan’s latest poll, which measures the percentage of investors that expect stock market prices to increase in the next year, expect stocks to generate another year of positive returns in 2018.24 October’s figure brings investor expectations for positive next-year returns to a nearly two-decade high.24
- Indeed, recent momentum could be a tailwind for continued market appreciation in 2018. But while sentiment remains supportive, equities could also face potential headwinds next year. The S&P 500 Index has climbed more than 16% year to date, and equity valuations currently appear to be stretched based on a variety of measures.25
- To this end, it may also be a reasonable interpretation for investors to read October’s nearly two-decade high sentiment figure as a potential warning sign that more volatile conditions could lie ahead, as was the case in mid-2007.
1 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
2 Bank of America Merrill Lynch U.S. High Yield Master II Index.
3 Bank of America Merrill Lynch U.S. High Yield Energy Index.
4 S&P Leveraged Commentary and Data Weekly Wrap, October 19, 2017.
5 Thomson Reuters Lipper.
6 Bank of America Merrill Lynch U.S. High Yield Metals and Mining Index.
7 Credit Suisse Leveraged Loan Index.
8 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
9 Bank of America Merrill Lynch U.S. 10-year Treasury Index.
10 Bank of America Merrill Lynch U.S. Corporate Master Index.
11 CNBC, http://cnb.cx/2yzg3gN.
12 Platts, http://bit.ly/2hTvyGC.
13 U.S. Energy Information Administration, http://bit.ly/1V2gPZQ.
14 Federal Reserve Bank of St. Louis, http://bit.ly/292Tgue.
15 Credit Suisse Leveraged Loan Index (energy component).
16 Alerian, http://bit.ly/2yKWiRz.
17 Standard & Poor’s, http://bit.ly/2ydsLD0.
18 Bloomberg, https://bloom.bg/2yBEZ5K.
19 Bloomberg, based on consensus analyst earnings expectations over the next 12 months.
20 Bloomberg, https://bloom.bg/2xSxVEO.
21 Federal Reserve Bank of St. Louis, http://bit.ly/2oMWaP2.
22 Federal Reserve Bank of St. Louis, http://bit.ly/2jZjDYt.
23 Federal Reserve Bank of Atlanta, http://bit.ly/1IYTEct.
24 Bloomberg as of October 19, 2017. Based on data from the University of Michigan Mean Probability of an Increase in Stock Market Prices in the Next Year.
25 Yale University, U.S. Stock Markets 1871–Present and CAPE Ratio is one measure among many by which stock market valuations appear to be above their long-term average, http://bit.ly/1qlZ47U.
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