Corporate credit gains in solid start of 2018
Corporate credit prices rose the first week of 2018 amid another record high for U.S. equities, solid economic data and investor optimism over the corporate tax cuts.1,2,3 High yield bond prices ticked higher throughout the week, providing a positive start to the year and extending the gains recorded throughout 2017. 4 After returning 0.29% in December, high yield bonds returned approximately 7.48% during 2017, outpacing U.S. 10-year Treasuries, investment-grade bonds and senior secured loans as investors continued to move down the corporate capital structure in search of yield.4,5,6,7 Underscoring this trend, CCC rated bonds outpaced their higher-rated peers for a second straight year.8 For 2017, CCC rated bonds, B rated bonds and BB rated bonds returned approximately 10.59%, 6.76% and 7.16%, respectively.8,9,10 Senior secured loans ended 2017 on solid footing, returning approximately 0.39% in December, which was the 21st positive return over the last 23 months.7 In all, senior secured loans returned approximately 4.25% during 2017 after returning 9.88% in 2016.7 Similar to the high yield bond asset class, lower-rated senior secured loans outpaced their higher-rated counterparts, with CCC rated senior secured loans returning approximately 8.10% during 2017.11 Spread compression continued to be a theme, as high yield bond yields tightened from approximately 6.17% at the outset of the year to end 2017 at 5.84%.12 This compares to investment-grade bond yields, which ended 2017 at approximately 3.28%, and senior secured loan yields, which ended 2017 at 6.33%.13,14
U.S. Federal Reserve signals slow and gradual path for interest rates
The Fed provided more details on its outlook for 2018 when it released the minutes of its December 12–13 meeting earlier this week.15 Assessing the outlook for the economy and the future path of rate tightening, Fed officials generally saw the risks to their outlook as balanced, expressed growing confidence in the strength of the labor market and reiterated their support for a gradual approach to raising rates.15 As for new fiscal stimulus from recently passed tax cuts, Fed officials noted the possibility of higher growth over the next few years: “Participants discussed several risks that, if realized, could necessitate a steeper path of increases in the target range; these risks included the possibility that inflation pressures could build unduly if output expanded well beyond its maximum sustainable level, perhaps owing to fiscal stimulus or accommodative financial market conditions..”15 Notably, at the December meeting officials increased their economic-growth estimates for the next three years, but didn’t lift their longer run expectations of growth from 1.8% nor change their expectation for three rate increases in 2018.16
Nonfarm payrolls report solid despite headline miss
U.S. Treasury yields declined following Friday’s release of December’s nonfarm payrolls report, but came back to relatively unchanged as investors absorbed the details of what was a relatively solid report.17 While the headline number of 148,000 came in below expectations, the unemployment rate remained at a multi-year low, the three-month average was robust and wages increased modestly.18 Average hourly earnings grew by 2.5% in 2017 and 9 cents, or 0.34%, in December, a slight pickup from recent months.18 December’s jobs report rounded out a week of somewhat mixed economic data, with the ISM manufacturing report surprising to the upside and the ISM non-manufacturing report surprising to the downside.19,20 However, investor optimism around economic and corporate earnings growth appears intact as U.S. equities continued to hit fresh record highs and the CBOE Volatility Index hovered near its record low.21,22 Looking to next week, the next logical catalyst for Treasuries is Friday’s Consumer Price Index (CPI) report.23 Recall that headline CPI increased 0.4% month-over-month in November, with core CPI rising a far more modest 0.1% month-over-month and slowed to 1.7% year-over-year.24
Chart of the week: 2017 was a year of strong returns with little volatility
- As 2017 came to a close, the S&P 500 Index continued its progress on what has been an unprecedented run. December 31, 2017 marked its 14th consecutive month of positive returns.25 Never before has the S&P 500 Index generated positive monthly returns for so long a period.25 In fact, its last negative monthly return came in October 2016, when it returned approximately -1.8%.25
- However, there is a strong relationship between equity valuations and forward returns. Periods of high equity valuations have historically been followed by relatively low future returns, and the inverse is true for periods of low equity valuations.
- The recent string of positive equity returns has been even more remarkable because it has come amid historically low levels of volatility.
- For example, the S&P 500 Index did not experience a single move, up or down, of 1% or more in 2017. It averaged almost 22 such days in each of the previous four years.26 Using another indicator, the CBOE Volatility Index, which measures market expectations and near-term equity volatility, averaged just 11.1 for the year and spent much of 2017 below 10.27 For context, this was far below the index’s historical average of approximately 19.1.27
- While no one knows for certain what the future holds for stock market performance, investors might be wise to watch market conditions should volatility once again enter the markets in 2018.
1 Federal Reserve Bank of St. Louis, DJIA, http://bit.ly/2jZjDYt.
2 BBC, http://bbc.in/2m32GP5.
3 USA TODAY, https://usat.ly/2Aw9Srt.
4 ICE BofAML U.S. High Yield Master II Index.
5 ICE BofAML U.S. 10-year Treasury Index.
6 ICE BofAML U.S. Corporate Master Index.
7 Credit Suisse Leveraged Loan Index.
8 ICE BofAML U.S. High Yield CCC Rated & Lower Index.
9 ICE BofAML U.S. High Yield B Rated Index.
10 ICE BofAML U.S. High Yield BB Rated Index.
11 Credit Suisse Leveraged Loan Index (CCC rated component).
12 ICE BofAML U.S. High Yield Master II Index (yield-to-worst).
13 ICE BofAML U.S. Corporate Master Index (yield-to-worst).
14 Credit Suisse Leveraged Loan Index (yield-to-a-three-year maturity).
15 U.S. Federal Reserve, FOMC minutes, http://bit.ly/2lYuhQJ.
16 U.S. Federal Reserve, Economic Projections, http://bit.ly/2Bh8q0L.
17 Federal Reserve Bank of St. Louis, U.S. 10-year yield, http://bit.ly/29ecBfp.
18 Bureau of Labor Statistics, http://bit.ly/2iYbHWM.
19 Institute for Supply Management, Manufacturing Index, http://bit.ly/2u7Z6Fq.
20 Institute for Supply Management, Non-Manufacturing Index, http://bit.ly/2g2jSi6.
21 Federal Reserve Bank of St. Louis, S&P 500, http://bit.ly/2d3pN5b.
22 Federal Reserve Bank of St. Louis, VIX, http://bit.ly/295DSwP.
23 Econoday, http://bit.ly/1iJOdAP.
24 Bureau of Labor Statistics, CPI, http://bit.ly/2jKLr2f.
25 Bloomberg based on total returns for the S&P 500 Index.
26 Bloomberg and FS Investments, as of January 4, 2018.
27 CBOE, http://bit.ly/2lSZupx. Historical average between January 2004 and December 2016.
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.