High yield bonds regain momentum
Corporate credit prices rose this week, with high yield bonds regaining ground lost the week before, amid firming U.S. growth expectations and solid fourth-quarter corporate earnings.1,2,3 Looking past the short-term effects of the U.S. government shutdown and rising U.S. Treasury yields, high yield bonds returned approximately 0.23% during the week ended January 25.1,4 This more than made up for the modest 0.04% decline sustained the week before and puts the asset class on track to generate its second straight monthly gain.1 Month to date, high yield bonds are now providing returns of approximately 0.91% despite resurfacing interest rate concerns and some sizeable weekly outflows.1,5 High yield bond mutual funds reported outflows of approximately $1.1 billion for the week ended January 24.5 This week’s outflow follows last week’s outflow of approximately $3.1 billion, which brings the year-to-date net outflow to $1.4 billion.5 Nevertheless, high yield bonds are on pace for their largest monthly gain since last July, led by relatively large price gains at the lower end of the credit ratings spectrum.1 For context, CCC rated bonds are returning 1.95% so far in 2018.6 This compares to B rated and BB rated bonds, which are providing year-to-date returns of 1.12% and 0.42%, respectively.7,8
Bank loan mutual funds see inflows
Senior secured loans posted another weekly gain, returning approximately 0.26% during the week ended January 25.9 With the U.S. 10-year Treasury yield briefly touching a multi-year high of 2.67%, investor attention has returned to the effect of rising rates on fixed income investments.10 Bank loan mutual funds recorded an inflow of $477 million for the week ended January 24, snapping a streak of 14 consecutive weekly outflows.5 Possibly benefiting from the asset class’s floating rate coupon and position as a potential hedge against the adverse effects of rising rates, senior secured loans are now providing month-to-date returns of approximately 0.85% and have outpaced high yield bonds in each of the past two weeks.1,9 For added perspective, investment-grade bonds, U.S. 2-year Treasury notes and U.S. 10-year Treasury notes are providing returns of -0.59%, -0.19% and -1.64%, respectively, through the same period.11,12,13
U.S. 2-year Treasury yields rise on solid growth
Short-end government bond yields rose this week as investors appeared to focus on accelerating growth and the prospect that a weaker U.S. dollar could help to spur inflation.14 Dollar weakness captured headlines this week after Treasury Secretary Mnuchin said that a “weaker dollar is good for trade,” adding some measure of volatility to the markets and leading to a further rise in the price of oil.15,16 A weaker U.S. currency could spur inflation by raising prices for imports and prompt a more aggressive path of rate increases by the U.S. Federal Reserve.17 On Friday, Fed funds futures showed a 35% chance that the Fed will raise short-term interest rates at least three times in 2018, up from 27% a month ago.18 The result was a flatter yield curve, with long-term Treasury yields remaining relatively steady and the U.S. 2-year Treasury yield rising to its highest level since September 2008.19 Short-term Treasury yields received a further boost after the advance estimate of fourth-quarter U.S. GDP confirmed solid growth.20 At 2.6%, the headline figure came in slightly below expectations, dragged lower by a decline in inventories and a wider trade deficit.20 However, consumer spending accelerated and business investment grew, contributing to a picture of ongoing economic momentum.20
Chart of the week: Global indexes struggled in the last two bear markets
- U.S. stocks touched another record high once again this week as the S&P 500 Index is in the midst of its best January return since 1997.21,22 Investors remain enthusiastic about the potential benefits of the recently signed tax bill along with the strong start to the current earnings season.
- As noted last week, the Dow Jones Industrial Average recently completed its fastest ever thousand-point climb when it moved from 25,000 to 26,000 in just 8 days.23 Following such a rapid move, many market valuation metrics sit at, or near, all-time highs.
- One such metric, the Shiller Cyclically Adjusted PE ratio, or CAPE, is currently at 33.6. It has only been higher once in its history, when it reached approximately 44.2 in 2000.24 It’s important to note that the market’s rising valuations have come at a time when volatility has been near a historic low point. The CBOE Volatility Index, at 11.52, currently sits at just over half its long-term average of approximately 19.3.25
- No one can predict when or where the market will move next. However, investors might be wise to watch market conditions should volatility once again enter the markets from such potential sources as Fed policy, consumer demand and employment trends.
- The chart highlights the performance across major equity asset classes during two recent downturns – the tech bubble that began in 2000 and the global financial crisis beginning in 2007. As shown, global diversification did not provide adequate protection to investors in either period.26 In both instances, performance across traditional asset classes remained highly correlated, generating significant declines across domestic, international and emerging market equities.26
1 ICE BofAML U.S. High Yield Master II Index.
2 FXStreet, http://bit.ly/2DEbpht.
3 Reuters, http://reut.rs/2GkhXE3.
4 Federal Reserve Bank of St. Louis, 2-year Treasury yield, http://bit.ly/2anGvQ0.
5 Thomson Reuters Lipper.
6 ICE BofAML U.S. High Yield CCC and Lower Rated Index.
7 ICE BofAML U.S. High Yield B Rated Index.
8 ICE BofAML U.S. High Yield BB Rated Index.
9 Credit Suisse Leveraged Loan Index.
10 Federal Reserve Bank of St. Louis, 10-year Treasury yield, http://bit.ly/29ecBfp.
11 ICE BofAML U.S. Corporate Master Index.
12 ICE BofAML U.S. 2-year Treasury Index.
13 ICE BofAML U.S. 10-year Treasury Index.
14 Federal Reserve Bank of St. Louis, U.S. dollar, http://bit.ly/2BuMvPG.
15 CNBC, http://cnb.cx/2BuM4oz.
16 OilPrice.com, http://bit.ly/2DFW4Bd.
17 Bloomberg, https://bloom.bg/2DEJhLl.
18 Bloomberg, based on CME data.
19 Federal Reserve Bank of St. Louis, 10 yr-2 yr, http://bit.ly/2oMWaP2.
20 Bureau of Economic Analysis, http://bit.ly/1DqcVBJ.
21 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
22 Bloomberg, as of January 25, 2018.
23 The Wall Street Journal, http://on.wsj.com/2Dm2qFI.
24 Online Data Robert Shiller, http://bit.ly/1qlZ47U.
25 CBOE Volatility Index, based on data between March 1990 through January 25, 2018.
26 Bloomberg, as of January 25, 2018. Domestic stocks represented by the S&P 500 Index. Global stocks represented by the MSCI World ex USA Index. Emerging market stocks represented by the MSCI Emerging Markets Index.
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.