Author: Josh Adams - Portfolio Manager

24 Jun 2022

CAM Investment Grade Weekly Insights

Investment grade credit has had a week of mixed performance.  The Bloomberg US Corporate Bond Index closed at 149 on Thursday June 23 after having closed the week prior at 144.  The market tone has been good for risk assets on Friday and it looks likely that spreads will finish the week on a positive note.  The 10yr Treasury is yielding 3.12% as we go to print after having closed the week prior at 3.23%.  The 10yr is down substantially from just 10 days ago when it closed at 3.47% on June 14.  Through Thursday the Corporate Index had a negative YTD total return of -14.42% while the YTD S&P500 Index return was -19.77% and the Nasdaq Composite Index return was -27.93%.

New issue activity returned this week but was relatively low volume as IG issuers brought just over $10bln in new debt to market. The consensus expectation is that there will be be about $15bln in issuance next week but it would not surprise us to see less or more than that figure, depending on market conditions.  There has been $708bln of new issuance YTD which trails 2021’s pace by 9% according to data compiled by Bloomberg.  It looks as though June will fall short of the $90bln estimate for new debt, with just $61bln priced thus far during the month.

Investment grade credit saw another outflow on the week.  Per data compiled by Wells Fargo, outflows for the week of June 16–June 22 were -$9.0bln which brings the year-to-date total to -$107.2bln.

17 Jun 2022

CAM Investment Grade Weekly Insights

It was a wild ride for risk assets during the week and credit spreads will finish the week wider.  The Bloomberg US Corporate Bond Index closed at 144 on Thursday June 16 after having closed the week prior at 136.  The tape has been mixed throughout the day on Friday and is pointing toward a close that looks as though it will be unchanged from Thursday.  The 10yr Treasury is yielding 3.23% as we go to print after having closed the week prior at 3.16% as rates sold off on the back of last Friday’s CPI print which showed that inflation has yet to show signs of slowing.  The 10yr was as low as 2.75% during the last week of May so it has been a significant move in a short timeframe.  The tape was particularly bad for equities this week as there was a brief relief rally on Wednesday post-FOMC but then a violent sell-off on Thursday.  The major indices have been modestly green throughout the day on Friday.  Through Thursday the Corporate Index had a negative YTD total return of -14.99% while the YTD S&P500 Index return was -22.5% and the Nasdaq Composite Index return was -31.6%.

The Federal Reserve delivered a 75bp Fed Funds rate hike on Thursday in its goal to curtail inflation.  It was the largest such rate increase since 1994.  The Fed may well deliver another hike of that magnitude at its July 27 meeting but that depends largely on the economic data between now and then.

The new issue calendar was non-existent this week as precisely $0 in new bonds were issued.  It was the first week of no issuance in 2022 and the first week with no new bonds since 2020 according to Bloomberg. The expectation is that there will be some modest issuance next week if the market tone is constructive.  As we often like to say, the IG market is essentially never closed but it is not uncommon for issuers to wait for a positive tone to issue with the hope that there will be enough investor demand to offer them favorable pricing.  There has been $697bln of new issuance YTD which trails 2021’s pace by 5% according to data compiled by Bloomberg.

Investment grade credit saw a sizeable outflow on the week.  Per data compiled by Wells Fargo, outflows for the week of June 9–June 15 were -$6.4bln which brings the year-to-date total to -$98.2bln.

03 Jun 2022

CAM Investment Grade Weekly Insights

Credit spreads will finish the week meaningfully tighter for the second week in a row.  The Bloomberg US Corporate Bond Index closed at 149 two weeks ago and 136 last Friday while the index closed this Thursday at an OAS of 130. Spreads have drifted wider during the trading day on Friday so we may close the week slightly wide of 130 but spreads will still finish the week better than where they started.  The 10yr Treasury is yielding 2.95% as we go to print after having closed the week prior at 2.74%.  IG corporate bonds posted their first monthly positive return of the year for May but the Corporate Index had a negative YTD total return of -11.79% through Thursday while the YTD S&P500 Index return was -12.11% and the Nasdaq Composite Index return was -21.3%.

Stocks traded lower on Friday on the back of payrolls data that was viewed as strong enough for the Fed to continue with its likely plan to raise Fed Funds by 50bps at its June meeting.  The next big economic release to watch is CPI on June 10 with the FOMC rate decision to follow on June 15.

The new issue calendar was robust this week considering Memorial Day made for a shortened week.  Issuers priced $29.9bln in new debt which was at the high end of estimates –financial institutions led the way with 75% of weekly volume.  Next week should be another active one for issuance especially if credit spreads continue their positive trajectory.

Investment grade posted another modest outflow this week.  Per data compiled by Wells Fargo, outflows for the week of May 26–June 1 were -$1.1bln which brings the year-to-date total to -$69.4bln.

27 May 2022

CAM Investment Grade Weekly Insights

Credit spreads will finish this week markedly better and there were a couple trading days where spreads ripped tighter.  The Bloomberg US Corporate Bond Index closed at 149 last Friday which was its widest level of the year.  The index closed 13 basis points tighter this Thursday at 136 and the path of least resistance feels tighter as we go to print this Friday morning.  Volumes are muted this morning before the long weekend and the market closes early this afternoon.  The 10yr Treasury is yielding 2.72% as we go to print after having closed the week prior at 2.78%.  The Corporate Index had a negative YTD total return of -11.68% through Friday while the YTD S&P500 Index return was -14.35% and the Nasdaq Composite Index return was -24.96%.

New issue for the week was a complete bust and didn’t even come close to the consensus estimate of $20bln+.  There was only one deal this week for a total of $500mm making it by far the slowest issuance week of the year.  The month of May has also been very underwhelming relative to expectations with just $73.85bln in issuance, well below the average estimate of $135bln.  There are two factors at play here, and they are entirely different in nature.  Issuance this week was slow merely because of the time of year –companies are often hesitant to issue ahead of a long weekend, especially with an early close on Friday, as it is typically perceived as a slower time in the capital markets and company treasury departments and CFOs worry that demand may not be as robust as they would like.  Companies certainly did not choose to shelve deals this week because of the market tone as the market was quite strong.  The monthly miss versus expectations was most certainly due to the volatility that we experienced in the weeks preceding this one.  There were many days of wider spreads and bloodletting in equities that would have led issuers and their bankers to simply “wait for a better day” to bring anticipated deals.  Projections for next week suggest $25-$30bln of new issuance.  There remain several very large deals waiting in the wings related to M&A so we could see some of those issuers look to print in the coming weeks if the market tone remains positive.

Investment grade flows have shown signs of stabilization the past two weeks.  Per data compiled by Wells Fargo, flows continued their negative trend but it was once again a very modest outflow.  Outflows for the week of May 19–25 were -$1.1bln which brings the year-to-date total to -$68.3bln.  Combined redemptions the past two weeks were the smallest over any two week period dating back to March according to Wells.

20 May 2022

CAM Investment Grade Weekly Insights

Credit spreads drifted wider this week while major equity indices posted their 7th consecutive week of losses.  The OAS on the Bloomberg US Corporate Bond Index closed Friday, the 20th of May at 149 after having closed the week prior at 141.  This marked the widest close for the index in 2022.  The 10yr Treasury closed the week lower, at 2.78% after closing the week prior at 2.92%.  The Investment Grade Corporate Index had a negative YTD total return of -12.99% through Friday while the YTD S&P500 Index return was -17.67% and the Nasdaq Composite Index return was -27.19%.

New issue volume showed a slight surprise to the upside during the week as $33.4bln of new debt exceeded the consensus estimate of $30bln. Projections for next week suggest $25-$30bln of new issuance.

Per data compiled by Wells Fargo, flows for investment grade were negative on the week.  Outflows for the week of May 12–19 were -$1.2bln which brings the year-to-date total to -$67.2bln.  This was smallest weekly redemption in 8 weeks according to Wells.

13 May 2022

CAM Investment Grade Weekly Insights

It was another volatile week for risk assets, especially equities.  The OAS on the Bloomberg US Corporate Bond Index closed Thursday, the 12th of May at 141 after having closed the week prior at 134.  The 10yr Treasury closed the previous week at 3.13% and it is trading at 2.91% as we go to print late Friday morning.  The Investment Grade Corporate Index had a negative YTD total return of -12.90% through Thursday while the YTD S&P500 Index return was -17.11% and the Nasdaq Composite Index return was -27.32%.

Key economic data hit the tape this week with CPI on Wednesday morning and PPI on Thursday.  CPI moderated from the previous month on a y/y basis but the headline number did surprise to the upside, as inflation did not slow as much as economists had predicted.  This likely keeps the Fed on its tightening path at its June meeting where the market is looking for a 50bps increase in Fed Funds.  PPI painted a picture of moderating inflation as the data showed that US producer prices increased more slowly in April than they did in March.

Volume in the investment grade primary market was less than investor expectations as $21.7bln in new debt was brought to market.  There were multiple issuers that stood down during the week preferring to wait for calmer market conditions.  Projections for next week are calling for $30bln of new issuance.

Per data compiled by Wells Fargo, flows for investment grade were negative on the week.  Outflows for the week of May 5–11 were -$7.7bln which brings the year-to-date total to -$60.1bln.  This was the largest weekly outflow from US IG in more than two years according to Wells.

06 May 2022

CAM Investment Grade Weekly Insights

One word can aptly describe this week: volatile.  The OAS on the Bloomberg US Corporate Bond Index closed Thursday, the 5th of May at 134 after having closed the week prior at 135.  Although the spread on the index was slightly tighter the performance effect was offset by higher Treasury yields.  The 10yr Treasury closed the previous week at 2.93% and it is trading at 3.14% as we go to print on Friday afternoon.  The Investment Grade Corporate Index had a negative YTD total return of -13.39% through Thursday while the YTD S&P500 Index return was -12.59% and the Nasdaq Composite Index return was -21.27%.

The Fed delivered a 50bp hike of the Fed Funds Rate on Wednesday afternoon which was promptly followed by an aggressive move higher in equities and a rally in Treasuries.  Credit spreads also moved tighter on the back of the FOMC.  These moves were somewhat puzzling to us but market prognosticators were quick to explain them as a reaction to Chairman Powell’s reluctance to pound the table on a 75bp rate hike.  Powell’s commentary was measured and led observers to believe that the Fed would not be hawkish at all costs and that the data would dictate their actions at subsequent meetings.  The grab for risk dissipated quickly Thursday morning with a big reversal in risk as equities gave back all of Wednesday’s gains and then some.  Friday too has been a relatively weak day for risk.  Equities have bled lower while Treasuries have sold off on the back of a relatively unsurprising jobs report.  Risk markets are not responding well to uncertainty and that has led to a roller coaster ride of volatility.  Meanwhile, in the investment grade credit markets, yields sit at their highest levels in more than a decade and credit conditions remain strong –we feel that valuations are compelling at the moment.

Volume in the investment grade primary market managed to chug along and land right in the middle of the $20-25bln estimate with $22.6bln in new debt having been brought to market during the week.  In our view this speaks to the resiliency of investment grade credit as it was pretty ugly out there yet borrowers were able to price new debt with reasonable concessions.

Per data compiled by Wells Fargo, flows for investment grade were negative on the week.  Outflows for the week of April 28–May 4 were -$5.3bln which brings the year-to-date total to -$52.8bln.

30 Apr 2022

CAM Investment Grade Weekly Insights

It was an ugly week for risk assets.  The OAS on the Bloomberg US Corporate Bond Index closed the week of April 29th at 135 after having closed the week prior at 132.  The month of April is one that investors would like to forget; it was historically bad for credit and stocks were down substantially.  All eyes will be on the Federal Reserve next Wednesday.  The market is pricing in a 50bps increase in the Fed Funds rate and is awaiting more details on balance sheet run-off.  The Investment Grade Corporate Index had a negative YTD total return of -12.73% through the end of the week while the YTD S&P500 Index return was -12.92% and the Nasdaq Composite Index return was -21.2%.

Volume in the primary market was underwhelming during the week and finished just under $9bln relative to estimates that were in the neighborhood of $25bln.  Per Bloomberg, this boosted the monthly total for April to $107.2bln.  Historically, May is a seasonally busy month and estimates are calling for $125-150bln of monthly supply.   While investor demand for high quality issuers has remained strong, we detect a sentiment of caution among borrowers as their funding costs are higher than they have been in several years so it will be interesting to see if May volume can keep pace with expectations.  There are some large bond deals waiting in the wings related to M&A that could come to market in May and it will also be interesting to see if investors demand higher new issue concessions from those borrowers who in some cases have to float large amounts of new debt.

Per data compiled by Wells Fargo, flows for investment grade were negative on the week.  Outflows for the week of April 21–27 were -$2.4bln which brings the year-to-date total to -$47.5bln.

22 Apr 2022

CAM Investment Grade Weekly Insights

Spreads drifted wider throughout the week and the tape is weak on Friday afternoon for credit and equites as we go to print.  The OAS on the Bloomberg US Corporate Bond Index closed at 128 on Thursday, April 21, after having closed the week prior at 121.  On Thursday, Federal Reserve Chairman Jerome Powell delivered a hawkish message that sent equities lower and credit spreads wider.  Geopolitical tensions and a humanitarian crisis Ukraine also continue to weigh on sentiment.  The Investment Grade Corporate Index had a negative YTD total return of -12% through Thursday.  The YTD S&P500 Index return was -7.4% and the Nasdaq Composite Index return was -15.6%.  The yield to worst for the Corporate Index is now 4.21%, closing in on the high of 4.57% that occurred during the early days of the pandemic in March of 2020.

The primary market was very busy this week with $55 billion in new debt having been brought to market.  Financials led the way with $33bln in issuance from money center banks.  Year-to-date issuance has now topped $551bln, slightly ahead of 2021’s pace.

Per data compiled by Wells Fargo, flows for investment grade were negative on the week.  Outflows for the week of April 14–20 were -$2.8bln which brings the year-to-date total to -$45.1bln.

11 Apr 2022

2022 Q1 Investment Grade Quarterly

It was an extremely painful start to the year for credit markets as performance suffered due to wider spreads and higher interest rates. During the first quarter, the option adjusted spread (OAS) on the Bloomberg US Corporate Bond Index widened by 24 basis points to 116 after having opened the year at an OAS of 92. Interest rates finished the first quarter higher across the board. The 10yr Treasury opened the quarter at 1.51% and closed 83 basis points higher, at 2.34%. The move in the 5yr Treasury was even more dramatic as it rocketed higher by 120 basis points, from 1.26% to 2.46%. The 2yr Treasury saw the most movement of all with a 160 basis point increase from 0.73% to 2.33%. The extreme move higher in interest rates led to negative returns for fixed income products across the board. The Corporate Index posted a quarterly total return of ‐7.69%, its second worst quarterly return in history. The only quarter that was worse than this one was the 3rd quarter of 2008 in the midst of the Great Recession when the index posted a quarterly return of ‐7.80%. CAM’s net of fees 1st quarter total return was ‐6.75%.

You own bonds, now what?

 Is now the time to panic? While we are certainly disappointed with short term negative performance we believe investors that are committed to the asset class will be rewarded over a longer time horizon. The thesis for owning investment grade credit as part of an overall diversified portfolio has not changed. Investors look to highly rated corporate bonds for diversification, income, and to decrease the volatility of their overall portfolio. While higher Treasury yields have led to negative performance for the past quarter it has also led to opportunity with investment grade yields that are now at their highest levels since the spring of 2019. Higher yields mean that newly issued corporate bonds will have larger coupons and more income generation.

For those who may view recent returns as a signal to either enter or exit certain asset classes, we would caution against such an attempt at market timing that currently might lead one to exit the investment grade corporate bond market. This is especially true when credit conditions are strong and the loss of value that occurred during the quarter was almost entirely driven by interest rates and not by the general creditworthiness of the investment grade universe. It is important to remember that bonds are a contractual obligation by the issuer – the bonds will continue to inch closer to maturity and pay coupons along the way. An investor who has seen a bond decrease in value will recapture some portion of that value over time in the form of coupon payments and an increase in principal value as the bond rolls down the yield curve toward maturity and its price converges toward par.

During the first quarter we experienced dramatically higher Treasury rates along with wider credit spreads. To put it into historical context, it was the second worst quarter for the Corporate Index since its inception in 1973. It is not easy to step in and buy here amid negative sentiment regarding the Fed and interest rates but we believe that is precisely what investors should be doing.

Credit Conditions

 The investment grade credit markets were in very good health at the end of the first quarter. The secondary market has been liquid and the primary market was fully functioning, even during the volatile period for risk assets that coincided with early days of Russia’s invasion of Ukraine. Cash on investment grade non‐financial firms’ balance sheets was at all‐time highs at the end of 2020 and 2021.i Leverage ratios for IG‐rated issuers spiked during the early innings of the pandemic but leverage has since come down substantially and is now below pre‐pandemic levels.ii In 2020, due to the early severity of the pandemic, there were $186bln in downgrades from investment grade to high yield. That trend reversed sharply in 2021 with just $7bln in downgrades during the entire year while there were $35bln in upgrades from HY to IG. 2022 will go down in history as the “year of the upgrade” and there were $31bln in upgrades during the first quarter of 2022 alone.

J.P. Morgan has identified an additional $230bln of HY‐rated debt that could make its way to investment grade by the end of 2022. There is a high probability that 2022 will shatter records for the most upgrades during a calendar year. As far as the new issue market is concerned, the numbers have been very strong. March was the 4th busiest month on record for the primary market with $229.9bln in volume. There was $453.4bln of new issuance through the end of the first quarter, which was 4% ahead of the pace set in 2021.iii In aggregate, the investment grade universe is strongly positioned from the standpoint of credit worthiness and access to capital. We believe this is supportive of credit spreads.

Inflation, Interest Rates, the Fed: Impact on Credit

 Inflation and interest rates are understandably a hot topic in our discussions with investors. Inflation is a problem, and headline PCE, which is the Fed’s preferred inflation gauge showed a year‐over‐year increase of

+6.4% for its February reading.iv Chairman Powell has responded with forceful rhetoric that the FOMC will do everything in its control to reign in price increases and the market has bought in. The consensus view is that inflation will slow throughout 2022. Along those same lines, it is widely anticipated that economic growth will slow throughout 2022 as well. At this point it seems likely that the Fed will raise its target rate by 50 basis points at its May and June meetings and then it could raise by 25 basis points in July, September, November and December. This is largely priced in at this point.v The risk with the Fed’s stance on inflation is that it could start to aggressively tighten monetary policy just as consumer spending begins to decline thus lighting the fire for a recession. History shows that it is very difficult for monetary policy to fight inflation and avoid a recession at the same time, thus the odds of a recession at some point over the next two years has increased substantially. Note that a recession simply means the economy has had two consecutive quarters of negative GDP growth –it is not a good thing, but a modest shallow recession does not necessarily mean economic disaster.

For credit, slower or negative growth likely means wider spreads but we would expect investment grade to outperform other risk assets in such a scenario. Investment grade balance sheet fundamentals are very strong and margins had been expanding until very recently and are near their peak. At some point, inflation will start to take a bite out of margins for some industries but in aggregate corporate credit is in very good health and well positioned to weather a storm. If the Fed manages to achieve its goal of a soft landing then that would be a scenario where risk assets perform reasonably well, but it could be accompanied by interest rates that inch higher from here, which would be a headwind for longer duration credit. An additional risk is that neither inflation nor economic growth decline in line with expectations throughout the rest of 2022; although we believe that this is the less likely of the two scenarios, it does remain a possibility that this path comes to fruition. If this happens then the Fed will have to become uber‐hawkish and may have no choice but to force the economy into recession to cool inflation.

What Does an Inverted Yield Curve Mean for Credit?

 As a reminder, at CAM we position client portfolios in intermediate maturities. We typically purchase bonds that mature in 8‐10 years and then allow those bonds to roll down the yield curve, holding them for 3‐5 years before we sell and redeploy the proceeds into another bond investment. We do this because the 5/10 portion of both the Treasury curve and the corporate credit curve have been historically typically steep relative to the other portions of both of those curves. We prefer a steep 5/10 Treasury curve but at the end of the 1st quarter that curve was ‐12 basis points. Our strategy still works when there is an inverted Treasury curve because there is a corporate credit curve that trades on top of the Treasury curve that classically steepens when the Treasury curve flattens resulting in extra compensation for incremental duration. See the below chart that compares the Treasury curve at quarter end against the corporate credit curves of two bond issuers:

Note that the curve for Charter is steeper than Progressive. This is typical given that Charter is a lower quality credit than Progressive; the curve should be steeper for incremental credit risk. Curves are moving all the time and change by the day or even by the hour. To provide some recent historical context, the 5/10 Treasury curve was 80+ basis points just one year ago, which was its steepest level at any time in the previous 5 years –things can change quickly. Corporate curves also vary by industry with fast changing industries like technology typically having steeper curves than stable more predictable industries. It is the constant monitoring of these curves and the subsequent implementation of trades where an active manager adds value to the bond investment management process.

There are a variety of reasons that Treasury curves invert but the main reason comes down to Federal Reserve policy and its impact on the front end of the Treasury curve. Increasing the Federal Funds Rate has a disproportionate impact on Treasuries that mature in 5 years or less and especially those that mature in 2 years. Longer term Treasuries like the 10yr are much more levered to investor expectations for economic growth and longer term inflation expectations. We would note that this Treasury curve inversion is still very fresh and corporate credit curves have steepened moderately in the meantime. Over time, if Treasuries remain inverted, we expect to see more steeping of corporate credit curves.

Looking Ahead

 It has been a tough start to the year but it is only April and there is still much to be written before we close the book on 2022. There are significant unknowns and risk factors that loom large as we navigate the rest of the year. The largest geopolitical uncertainty is the Russo‐Ukrainian War but China’s “zero‐Covid” policies are another risk that may not be fully appreciated by the markets as a slow‐down in China could have significant ramifications for global economic growth. Domestically, Federal Reserve policy is at the forefront and there are also mid‐term elections in the fall.

We believe higher Treasury yields and reasonable valuations for credit spreads along with healthy credit conditions for investment grade issuers have made the investment grade asset class as attractive as it has been in several years. The risk to our view is that Treasury yields could go even higher from here creating additional performance headwinds for credit.

We will be doing our best to navigate the credit markets in a successful manner the rest of this year and we appreciate the trust you have placed in us as a manager. Thank you for your business and please do not hesitate to contact us with any questions or comments.

This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.

 The information provided in this report should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein

i Goldman Sachs Global Investment Research, March 28 2022, “IG capital management: Deleveraging is the exception, not the rule”

ii Bloomberg, Factset, Goldman Sachs Global Investment Research

iii Bloomberg, March 31 2022, “IG ANALYSIS: Corebridge Debut Closes Out Record $230bln Month”

iv CNBC, April 1 2022, “The Fed’s preferred inflation gauge rose 5.4% in February, the highest since 1983”

v Bloomberg, March 14 2022, “Fed Traders Now Fully Pricing In Seven Standard Hikes for 2022”