Covering (Or We Guess We Should Say Closing) The Spread
I come to capital markets through the equity end of things, having served as an analyst and portfolio manager on long/short and long-only equity-facing strategies earlier in my career before transitioning into a Chief Investment Officer role. During my career, I have been fortunate to work with brilliant equity analysts and portfolio managers. I have also been fortunate to work with brilliant fixed income analysts and portfolio managers, which brings us to the focus of this week’s Weekly Wire and that is the bond market, or more specifically, what the cost of capital for non-investment grade (i.e., high yield or junk bond issuing) companies might be telling us about the outlook for the economy.
Before we dig in on that front, most fixed income investors will gladly let you know that 1) the bond market is more important than the stock market and 2) fixed income investors are smarter than equity investors (for my 2 cents, I agree with the former point; I take great umbrage with the latter). So, what might the all-important bond market be telling us about the outlook for the economy? Using the spread or difference between the yield on an index of non-investment grade bonds and a spot US Treasury curve (or “risk-free” rate), the signal seems to be one of diminishing concern over the outlook for the US economy. To put a finer point on it, the spread or difference between the yield on non-investment grade bonds and Treasuries has fallen to 4.25% or 425 basis points, which is above recent lows of 3% or 300 basis points but well off the recent high of 6% or 600 basis points and far removed from levels reached during periods of economic distress, including early 2020 when the gap approached 10% or 1000 basis points (see chart).
Another way to think about the dataset as it ties back to the outlook for the US economy is that investors are demanding a higher yield on bonds from non-investment grade companies relative to a risk-free alternative – which is to be expected – but not a yield that speaks to real concern for the outlook for those non-investment grade companies. The second half has been much better for risk assets than the first, and recent economic data has been, on balance, solid. We are hopeful both trends will persist into year-end.
The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital Investments, LLC, a registered investment advisor. 1519-BCI-8/22/2022