Category: Insight

19 Feb 2021

CAM Investment Grade Weekly Insights

Spreads continued their slow burn this week, gradually inching tighter.  The OAS on the Bloomberg Barclays Corporate Index closed at 88 on Thursday evening after ending the week prior at 92.  Treasuries are at their highest levels of the year for the second consecutive week.  The 10yr Treasury closed last week at 1.21% and it is trading at 1.35% as we go to print this Friday afternoon.  Through Thursday, the corporate index had posted a year-to-date total return of -2.07% and an excess return over the same time period of +0.83%.



The high grade primary market was light during the holiday shortened week with only $14bln in new issuance.  Concensus estimates for next week are calling for $30-$40bln in new issuance, according to Bloomberg surveillance.

Per data compiled by Wells Fargo, inflows into investment grade credit for the week of February 11-17 were +$7.6bln which brings the year-to-date total to +$73bln.

Price action in Treasuries the past two weeks has been wrapped around investor views of stimulus and inflation.  As vaccinations increase and infections decrease, global economies can be expected to exit their slumber.  We think there is a consensus among market participants that inflation is likely to increase throughout 2021 and into 2022 but we are of the view that there is much uncertainty regarding the degree of the relfation trade.  There are numerous areas of the economy that could take years to recover while there are some sectors that have already recovered and those that will bounce back even stronger.  Are sustainable broad based price increases across the vast majority of the economy possible?  Anything is possible, but we would argue that an extraordinarily robust recovery over a short time period is unlikely – but let’s assume this does come to fruition.  While the Fed has said it would tolerate temporary inflation above its targeted level, if it were to view this as something more than fleeting, and if it were to view the economy as “overheating” then it could well accelerate the timeline for raising the Fed Funds Rate.  A higher Fed Funds Rate typically leads to tighter financial conditions and slowing growth, which would put a brake on any reflation trade.  The point is that yes, we think reflation is likely, especially in certain sectors of the economy.  But even if the domestic economy were to recover much more quickly than expected, we are skeptical that the Fed will allow significant levels of inflation without Fed Policy intervention.


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.


19 Feb 2021

CAM High Yield Weekly Insights

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were -$0.1 billion and year to date flows stand at $1.8 billion.  New issuance for the week was $3.0 billion and year to date issuance is at $75.4 billion.

  (Bloomberg)  High Yield Market Highlights

  • The U.S. junk bond market is wrapping up the slowest week for issuance this year with just $3 billion of debt sold so far, and no deals as yet slated to price Friday. Average yields, meanwhile, have bounced off all-time lows reached earlier this week.
  • As new issuance slowed, investors piled billions of dollars into offerings that did come to market even as high-yield funds saw an outflow this week
  • February issuance volume is running at almost $25b, about $5b away from the total amount sold in the same month last year, according to data compiled by Bloomberg
  • CCCs, the riskiest junk bonds, have accounted for 25% of bond sales this month. Issuers have ranged from energy firms to covid-hit borrowers from the travel, leisure and entertainment sectors
  • Average junk bond yields rose 3bps to 3.99% Thursday, but are still just 10bps off the record low set earlier this week
  • The broader index posted a loss of 0.05% on Thursday, the second consecutive session of negative returns, and the biggest one-day loss in three weeks

(Bloomberg)  BB Junk-Bond Yields Drop Below 3% for the First Time Ever

  • The average yield on U.S. junk bonds in the Double-B tier dropped below 3% for the first time ever on Tuesday as investors continue to pile into an asset class historically known for its high yields.
  • The average yield on BB debt, the safest of junk bonds, fell 7bps to a record low of 2.98%, according to Bloomberg Barclays index data
  • The measure for the broader U.S. Corporate High-Yield index dipped to 3.89%, down 7bps in the biggest one-day decline in about seven weeks, the data show
  • CCC yields also fell to a new low of 6.11% amid calls from some credit strategists to selectively buy the riskiest of junk bonds to boost returns
  • There is “no reason to be bearish” and cash levels are down to just 3.5%, an eight-year low, Bank of America wrote in the report based on a survey of global fund managers
  • More borrowers are expected to sell new debt to take advantage of cheap borrowing costs and strong demand from investors
  • CCC debt has gained 1.19% in February, and 2.69% since the start of the year, beating all other rating buckets in the junk bond market
  • The broad junk index has gained 1.02% month-to-date and 1.36% year-to-date
  • The rally may continue with oil closing at a 13-month high near $60as a winter storm halts a third of U.S. crude output

(Wall Street Journal)  Saudis Plan to Reverse Oil Cuts as Prices Rise

  • Saudi Arabia plans to increase its oil output in the coming months, reversing a recent big production cut, advisers to the kingdom said, a sign of growing confidence over an oil-price recovery.
  • The world’s largest oil exporter surprised oil markets last month when it said it would unilaterally slash 1 million barrels a day of crude production in February and March in an effort to raise prices.
  • But the kingdom plans to make public a reversal of those cuts when a coalition of oil producers meet next month, the advisers said, in light of the recent recovery in prices. The output rise won’t kick in until April, given the Saudis already have committed to stick to cuts through March.
  • The advisers cautioned the plans still could be reversed if circumstances change, and the Saudis’ intention hasn’t yet been communicated to the Organization of the Petroleum Exporting Countries, the people and OPEC delegates said.
  • “We are in a much better place than we were a year ago, but I must warn, once again, against complacency,” Prince Abdulaziz bin Salman, the Saudi energy minister, said at a conference on Wednesday. “The uncertainty is very high, and we have to be extremely cautious.”
  • “A Saudi increase in production. . .makes perfect sense given the tightness that is starting to emerge in the market,” said Ole Hansen, head of commodity strategy at London-based Saxo Bank. “The market will probably take it quite well.”
  • The planned Saudi move to restore supplies isn’t expected to immediately spark large output increases from other big producers, analysts said, given the kingdom is acknowledged to have carried the biggest burden in reducing production.
  • However, analysts do expect compliance with output curbs among producers to be increasingly loose as the recovery gains momentum.
12 Feb 2021

CAM High Yield Weekly Insights

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were -$0.9 billion and year to date flows stand at -$0.1 billion.  New issuance for the week was $15.1 billion and year to date issuance is at $72.3 billion.  

(Bloomberg)  High Yield Market Highlights 

  • In terms of issuance, this has been the second busiest week of the year, according to data compiled by Bloomberg. With yields at record lows, more borrowers are expected to hit the market after the long weekend.
  • High-yield funds returned to outflows for the week, following an inflow of $1.34b last week
  • Investors are still buying new issues in droves, and the risky debt is headed for its second straight week of positive returns
  • The Bloomberg Barclays U.S. Corporate High-Yield index yield held steady at a record low of 3.95% on Thursday
  • A strong technical backdrop and improving fundamentals could drive spreads even tighter in the short term, Barclays Plc credit analysts led by Brad Rogoff wrote in a note Friday
  • A roster of formerly distressed companies have sold notes this week and CCCs, the riskiest junk bonds, accounted for about 19% of total bond sales, the data compiled by Bloomberg show
  • CCC yields rose to 6.19%, just 3bps off an all-time low of 6.16% 

(Bloomberg)  U.S. Junk-Bond Yields Drop Below 4% for the First Time Ever

  • The average yield on U.S. junk bonds dropped below 4% for the first time ever as investors seeking a haven from ultra-low interest rates keep piling into an asset class historically known for its high yields.
  • The measure for the Bloomberg Barclays U.S. Corporate High-Yield index dipped to 3.96% on Monday evening, making it six straight sessions of declines.
  • Yield-hungry investors have been gobbling up junk bonds as an alternative to the meager income offered in less-risky bond markets. Demand for the debt has outweighed supply by so much that some money managers are even calling companies to press them to borrow instead of waiting for deals to come their way. A majority of new issues, even those rated in the riskiest CCC tier of junk, have been hugely oversubscribed.
  • The lower yields should encourage more speculative-grade companies to tap the market after raising more than $7 billion last week. January was a record month for sales with $52 billion priced.
  • Buyers have been snapping up CCC graded issues as yields for that slice of high yield also decline. They dropped to 6.21% on Monday, also a record low, and have outperformed the rest of the market for three consecutive months, according to data compiled by Bloomberg.
  • Issuance conditions have been so conducive that some of the riskiest types of transactions come to market, such as bonds that are used to fund dividends to a company’s owners and so-called pay-in-kind bonds that allow a borrower to pay interest with more debt.
12 Feb 2021

CAM Investment Grade Weekly Insights

Spreads initially ripped tighter on Monday of this week before giving back some gains, but it looks like the index will still end the week tighter, or at worst, unchanged.  The OAS on the Bloomberg Barclays Corporate Index closed at 92 on Thursday evening after ending the week prior at 93.  Treasuries are at their highest levels of the year across the board and curves continue to steepen.  The 10yr Treasury closed last week at 1.16% and it is hovering around 1.19% as we go to print on this Friday morning.  Through Thursday, the corporate index had posted a year-to-date total return of -1.45% and an excess return over the same time period of +0.49%.

The high grade primary market was more subdued this week with only $16bln in new issuance.  Next week, too, may see lower volumes with the market closed for Presidents Day on Monday, but midway through February we are on pace for $120bln of issuance which is quite a strong number.

According to data compiled by Wells Fargo, inflows into investment grade credit for the week of February 4-10 were +$2.1bln which brings the year-to-date total to +$40bln.

In our recent discussions with some of our clients, the topic of inflation and rising rates has been coming up with increasing frequency.  We have long warned of the folly of trying to predict moves in interest rates.  That is one of the reasons that we always position our portfolio in intermediate maturities rather than attempting to tactically switch between long and short maturities based on our guess as to the direction of rates.  To put recent rate moves into context, the 10yr Treasury closed at 0.51% on August 4, 2020 and it has more than doubled since then, closing at 1.18% on February 11, 2021.  If we look at returns for the Corporate Index over this same time frame you may be surprised to learn that the total return for the index was only modestly negative at -0.38% total return; and you would be hard pressed to cherry pick a worse timeframe for returns from a rate presepective!  The reason that corporate credit returns can be relatively resilient in the face of rising rates is due to the power of spread compression and coupon income.  Over that same period the index saw its spread compress from 131 to 92 and then investors also earned a coupon from corporate credit that was greater than the coupon earned from investing in duration matched Treasuries.  Could rates continue to go higher from here?  Yes of course they could, just as they could go lower.  But we would be surprised to see them go materially higher in the near term as our expectations for inflation remain relatively subdued relative to what seems to be a growing market concensus.  We will explore some of the reasons why inflation is not necessarily something investors should bank on in our future weekly commentaries.  Thank you for your interest and continued support.



05 Feb 2021

CAM High Yield Weekly Insights

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were $2.5 billion and year to date flows stand at $0.8 billion.  New issuance for the week was $13.3 billion and year to date issuance is at $57.2 billion.

(Bloomberg)  High Yield Market Highlights

  • U.S. junk bond yields hit a new all-time low of 4.09%, while funds that buy the risky debt saw their first weekly influx of cash this year. Great Western Petroleum could be the latest energy company to benefit from the wide-open market, looking to clear out near-term maturities and land a higher credit grade with a debt sale that’s due Friday.
  • The high-yield market is headed for the biggest gains in a little more than two months, according to data compiled by Bloomberg, and yields may fall further with credit risk lower, and stock futures advancing after the U.S. Senate voted to adopt a budget blueprint for a $1.9 trillion stimulus package
  • The market’s also getting a boost from rising oil prices, which climbed close to $60 a barrel
  • Investors poured money into high-yield funds for the week. It follows four straight weeks of outflows
  • Investors are snapping up debt in the riskiest CCC tier that’s notched up gains of more than 2% already this year. Yields on the debt have plunged to 6.48%, just 6bps off the record low of 6.42%
  • “Stressed credits have historically been a good place to look for strong returns,” Barclays Plc credit analysts led by Brad Rogoff wrote in a note Friday
  • In the primary market, more than a third of sales this week have been deals with ratings in the CCC bucket.
  • Average junk-bonds have gained 0.56% this week, the best in about two months
  • BB yields closed at a new all-time low of 3.16%
  • CCCs posted gains of 0.2% on Thursday, the best asset in the high yield market. It is set to post gains of 0.67% for the week

(Bloomberg)  Credit Upgrade Cycle Is in Full Swing Amid Signs of Recovery

  • As the U.S. economy shows more signs of recovering from the worst of its pandemic doldrums, the credit upgrade cycle is in full force.
  • Junk companies are seeing their ratings increased in droves, with upgrades so far this quarter reaching the highest level relative to downgrades since the end of 2013, according to data for the U.S. compiled by Bloomberg. That’s a big about-face from last year, when the pandemic weighed on companies’ profits and triggered a near unprecedented rate of downgrades.
  • With governments in the U.S. and Europe providing extensive support to the economy, low interest rates boosting the money supply, and signs of an improving economy, there’s a wave of upgrades happening now, according to Christina Padgett, head of leveraged finance research at Moody’s.
  • Companies are refinancing shorter-term loans they got at the height of the pandemic and turning them into longer-term obligations, which is also a positive sign, she said. Boeing Co., which Moody’s rates at Baa2 or the second-lowest investment-grade level, sold $9.825 billion of bonds Tuesday, refinancing some of the $13.8 billion loan it drew down at the beginning of the Covid-19 outbreak.
  • “We do see light at the end of the tunnel,” said Padgett in an interview. “The economy both in the U.S. and Europe will grow materially this year.”
  • U.S. initial jobless claims fell last week to the lowest level since the end of November, a signal that job cuts are starting to slow as Covid-19 infections ebb, according to a report on Thursday.
  • Even with economic improvement, junk-rated companies still face trouble, including the higher debt loads many of them now bear, said Moody’s Padgett. Shedding those obligations could be difficult.
  • “If you were very levered going into the downturn, it is going to be much harder to exit with a sustainable capital structure,” she said.
  • Ratings firms may have been too quick to downgrade in the first place, Bank of America Corp. credit strategists led by Hans Mikkelsen wrote on Wednesday.
  • “Rating agencies overreacted to the Covid-crisis when downgrading investment-grade companies during the first part of 2020, and to compensate there will be an upgrade cycle this year,” Mikkelsen wrote.
  • The number of companies facing near-term potential downgrades, among issuers rated AAA to B-, dropped for the fifth consecutive month to 1,178 on Dec. 25, from a historic high of 1,365 in July, S&P Global Ratings said in a report Tuesday. The downgrade risk among non-financial companies, however, remains elevated this year, with airlines as a vulnerable industry.


05 Feb 2021

CAM Investment Grade Weekly Insights

Price action in the corporate bond market this week would best be described as “grabby” with spreads consistently grinding tighter throughout the week. Spreads were wider the week before last but they have since reclaimed that ground that was given up. The Bloomberg Barclays US Corporate Index closed on Thursday February 4 at 94 after closing the week prior at 97. Treasuries are higher across the board this week and curves are at their steepest levels of the year. The 10yr Treasury closed last week at 1.065% and it is 8 basis points higher as we go to print on this Friday morning. Through Thursday, the corporate index had posted a year-to-date total return of -1.61% and an excess return over the same time period of +0.27%.

The high grade primary market saw solid volumes during the week on the back of a jumbo $14bln print from Apple. Over $45bln priced during the week. Year-to-date issuance stands at $172.8 billion. Investor demand for new issuance remains quite strong as the U.S. corporate bond market is one of the last bastions for positive nominal yields globally.

According to data compiled by Wells Fargo, inflows into investment grade credit for the week of January 28-February 3 were +$7.9bln which brings the year-to-date total to +$37.9bln.



22 Jan 2021

CAM High Yield Weekly Insights

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were -$0.3 billion and year to date flows stand at -$0.3 billion.  New issuance for the week was $16.7 billion and year to date issuance is at $32.9 billion.

 (Bloomberg)  High Yield Market Highlights

  • Yields on CCC debt, the riskiest of junk bonds, have hit an all-time low of 6.42% as investors seek bigger returns by moving down the credit curve. US LBM Holdings is the latest borrower to reap rewards from that chase, receiving more than $2.5 billion of demand for a $400 million pay-in-kind bond with ratings in the CCC tier to fund a dividend to Bain Capital.
  • The recent CCC tightening has been driven by bond-level performance rather than shifts in the index constituents, Barclays Plc credit strategists led by Brad Rogoff wrote in a note Friday
  • There is still room for higher-beta credits to compress, but investors should be selective given some continued Covid-related weakness.
  • The CCC index has rallied for 20 straight sessions to post gains of 0.17% on Thursday, and has outperformed other parts of junk for about 11 weeks, according to data compiled by Bloomberg
  • Yields on the broader junk bond index also dropped to a record low of 4.10%, though the rally may stall with credit risk higher, stock futures falling and oil prices lower amid renewed fears that the spread of coronavirus may force more lockdowns
  • S. high-yield funds reported an outflow for week, the third straight week of exits, but new issues are still being inundated with demand
  • The market stands about $2.5b away from making this month the busiest January ever as companies continue to churn out debt offerings to meet voracious demand

(CNBC)  IEA cuts 2021 oil demand outlook

  • The IEA said it now expects world oil demand to recover by 5.5 million barrels per day to 96.6 million this year. That reflects a downward revision of 0.3 million barrels from last month’s assessment.
  • The report comes as countries continue to implement strict public health measures in an attempt to curb virus spread, with lockdowns imposed in Europe and parts of China.
  • Oil prices have rallied in recent weeks, supported by optimism over Covid vaccine rollouts and a surprise oil production cut from OPEC kingpin Saudi Arabia.
  • “The global vaccine roll-out is putting fundamentals on a stronger trajectory for the year, with both supply and demand shifting back into growth mode following 2020′s unprecedented collapse,” the IEA said in its closely-watched report.
  • “But it will take more time for oil demand to recover fully as renewed lockdowns in a number of countries weigh on fuel sales,” it added.

(New York Times)  Biden Cancels Keystone XL Pipeline and Rejoins Paris Climate Agreement

  • President Biden on Wednesday recommitted the United States to the Paris climate agreement, the international accord designed to avert catastrophic global warming, and ordered federal agencies to start reviewing and reinstating more than 100 environmental regulations that were weakened or rolled back by former President Trump.
  • Biden has elevated tackling the climate crisis among his highest priorities.
  • “We’re going to combat climate change in a way we have not before,” Mr. Biden said in the Oval Office on Wednesday evening, just before signing the executive orders. Even so, he cautioned: “They are just executive actions. They are important but we’re going to need legislation for a lot of the things we’re going to do.”
  • Also on Wednesday, Mr. Biden rescinded the construction permit for the Keystone XL oil pipeline, which would have transported carbon-heavy oil from the Canadian oil sands to the Gulf Coast. Earlier in the day, TC Energy, a Canadian company, said that it was suspending work on the line


(CAM Note)  As we go to print, the WTI crude oil price is down 2.5%.

22 Jan 2021

CAM Investment Grade Weekly Insights

Spreads are looking likely to finish the holiday shortened week with little change.  The Bloomberg Barclays US Corporate Index closed on Thursday January 21 at 94 after closing the week prior at 94.  Treasuries have hardly moved this week and are currently less than 2 basis points lower since last Friday.  Through Thursday, the corporate index had posted a year-to-date total return of -1.22%.

The high grade primary market saw reasonable volume during the week that was right in line with concensus expectations.  Over $25bln priced during the week.  Year-to-date issuance stands at $100.3 billion.

According to data compiled by Wells Fargo, inflows into investment grade credit for the week of January 14-20 were +$7.7bln which brings the year-to-date total to +$22.7bln.


08 Jan 2021

CAM High Yield Weekly Insights

(Bloomberg)  High Yield Market Highlights 

  • Urban One Inc. is slated to sell an $825 million seven-year note Friday, which would push issuance this week to about $8 billion. The junk bond primary has been dominated by energy companies, and more deals could emerge with oil prices rallying.
  • Energy companies have accounted for more than 60% of the issuance volume this week, fueled by rising oil prices and a drop in energy index yields to below 6% for the first since January 2018, according to data compiled by Bloomberg
  • Brent crude topped $55 a barrel, while West Texas Intermediate rose above $51, its highest since February 2020
  • The energy index returned 0.39% Thursday, and has gained for 11 straight sessions
  • Broader junk bond yields closed at 4.17%, and spreads at +350bps. Spreads were at a new 10-month tights, and yields were just 1bp above the all-time low yield of 4.16%
  • Barclays Plc credit strategist Brad Rogoff expects the risk rally to continue as “the probability of increased fiscal support will continue to outweigh any concerns on potentially higher corporate taxes”

(Wall Street Journal)  Saudis to Cut Output In Bid to Lift Oil Price

  • Saudi Arabia said it would unilaterally cut one million barrels a day of crude production starting next month, a surprise move signaling the kingdom’s worry that a resurgent coronavirus is threatening global economic recovery.
  • The announcement Tuesday came after Riyadh agreed earlier in the day with other big producers to keep the group’s collective output flat, after a now-monthly assessment by the Saudi-led OPEC cartel and a group of big producers led by Russia. In that deal, the two groups, collectively called OPEC-plus, agreed to a complex deal to hold production broadly unchanged from current levels.
  • Oil prices, which had already risen sharply on news of the OPEC-plus deal, soared on the Saudi announcement. In early-afternoon trading Tuesday, West Texas Intermediate futures, the U.S. benchmark, were up 5.2% a barrel, passing through the $50 mark for the first time since last February.
  • Saudi Energy Minister Abdulaziz bin Salman said the unilateral move was made “with the purpose of supporting our economy, the economies of our friends and colleagues, the OPEC-plus countries, for the betterment of the industry.”
08 Jan 2021


Investment grade corporate bonds rode a roller coaster in 2020 so it should be no surprise that, after peaks and valleys, spreads finished the year nearly right where they started. The option adjusted spread (OAS) on the Bloomberg Barclays US Corporate Bond Index opened the year at 93, but soon thereafter, pandemic induced uncertainty gave way to panic stricken selling, sending the OAS on the index all the way out to 373 by the third week of March– its widest level since 2009, during the depths of The Great Recession. On March 23, the Federal Reserve announced extensive measures to support the economy and liquidity within the bond market and spreads reacted in kind, grinding tighter. There were pockets of volatility along the way, but absent a few hiccups it has been a one-way trade of tighter spreads since the end of March, with the OAS on the index finishing 2020 at 96; a mere 3 basis points wider on the year.

Lower Treasuries were the biggest driver of performance for credit during the year. The 10yr Treasury opened 2020 at 1.92% and closed as low as 0.51% at the beginning of August before finishing the year at 0.91%. The Corporate Index posted a total return of +3.05% during the fourth quarter and a full year total return of +9.89% for 2020. This compares to CAM’s gross quarterly total return of +1.86% and full year gross return of +8.73% for 2020.

2020 Investment Grade Returns – What Worked & What Didn’t?

The big winner in 2020 was duration, with lower rates leading to higher prices for bonds, all else being equal. Although the Corporate Index was up almost 10% for the year, excess returns, which measure the performance of corporate credit excluding the benefit of lower Treasury rates, were modest. The sectors that posted the best excess returns in 2020 were Basic Industry, Technology and Financials. At the sector level, Energy was the worst performer with an excess return of -5.97%, with particular underperformance for Independent Energy, which as an industry posted a 2020 excess return of -11.27%. Also at the industry level, Airlines predictably underperformed, with a 2020 excess return of -8.91%.

What to Expect in 2021?

With equity indices at all-time highs and yields on corporate bonds at all-time lows, where do we go from here? In our opinion, the theme for 2021 should be one of guarded optimism. Vaccinations have been approved and are being administered and there are more in the pipeline. Healthcare providers have become more adept at managing care and therapeutic treatments are more readily available. The policy response from the Federal Reserve has been strong and the Fed stands ready and willing to lend more support if it is needed.

As far as investment grade bonds are concerned, we expect a transition to occur as we enter 2021 and that the script will flip from 2020’s broad based risk rally to more of a credit pickers environment in 2021, where bottom up fundamentals become more important and investment managers must carefully evaluate the risks and potential rewards for each individual position within a portfolio. Credit spreads and Treasuries are beginning the year at levels that do not set-up well for the type of returns we experienced in 2019 and 2020, when the corporate index tallied gains of +14.54% and +9.89%, respectively. But outsize returns over short time horizons are not the best case for owning investment grade corporate bonds. Advisors and clients that we talk to favor investment grade corporate bonds for their low volatility, the diversification benefit they provide to an overall portfolio or their ability to generate income in a safer manner than relatively more risky asset classes. These traits are magnified over longer time horizons and thus the asset class lends itself to being more strategic in nature as an allocation within a portfolio.

As we turn the page to the New Year we see several factors that could lend support to credit spreads in 2021.

  • Lower New Issue Supply in 2021 – Investment grade borrowers issued nearly $1.75 trillion of new debt in 2020 which shattered the previous record by 58%i. Bond dealers are expecting as much as $1.3 trillion of issuance in 2021, but most estimates are falling around $1.1 trillion. Even at the high end of the estimated range, the expectation is for substantially less supply. Demand overwhelmed supply the last several months of 2020 as evident by oversubscribed order books and narrow new issue concessions (the extra compensation/yield that issuers use to compensate investors in order to entice them to buy their new bonds versus their existing bonds). An environment with excess investor demand is supportive of spreads in the secondary market.
  • It’s Just Math: Global Edition – Even though US nominal yields are low, they are still meaningfully higher than foreign investors can find elsewhere. There was $17.8 trillion in negative yielding debt around the globe at the end of 2020ii. The following developed countries had negative 10yr sovereign bonds at conclusion of the year: France, Germany, Netherlands, and Switzerland. Sweden had a 10yr yield at year end of 0.009% and Japan was at 0.013%. Simply put, foreign investors have very few options, and many, such as pensions and insurance companies, must generate a return by investing in high quality assets. The U.S. investment grade credit market is the largest, deepest and most liquid bond market in the world by an order of magnitude. There is some nuance at play here in that these investors must account for hedging costs and that can cause demand to ebb and flow at times but they will remain an important fixture in our market for the foreseeable future and their demand is a technical tailwind for spreads.
  • Improving Economy – We expect that the economy will see solid improvement in 2021 but that it will be highly industry/company specific. Some industries are still significantly impaired, and some will be impaired permanently. There will be some opportunities in industries that are facing temporary headwinds. As earnings recover it will be important for an investment manager to differentiate among those companies who will use the earnings recovery for balance sheet repair versus those who may choose to engage in M&A, shareholder rewards or adopt a more aggressive financial policy by operating with higher leverage.
  • Yields are Low, but Curves are Steep – Of particular importance to an intermediate manager like CAM, is the steepening that we have seen in the 5/10 Treasury curve. If you are a repeat reader, you know that we are interest rate agnostic and that we typically buy 8-10yr bonds and allow those bonds to roll down the curve to 4-5yrs before we sell and redeploy the proceeds back out the curve. The 5/10 curve ended the year at 55 basis points which was near its highest levels of the year, after averaging less than 35 basis points during 2020. For context, the 5/10 curve closed above 30 on only one day for the entire two year period from the beginning of 2018 to the end of 2019. A steeper curve allows for more attractive extension trades and offers better roll-down potential for current holdings. It is a mechanism that allows a manager to generate a positive total return despite a low rate environment.

Like any investment process, there are risks to our view as well.

  1. Inflation – We think that 2021 will be a year that is rife with inflation scares and that it could lead to volatility in Treasuries and corporate bond valuations. In fact, the first trading day of 2021 generated a headline as the 10yr breakeven rate surpassed 2% for the first time in over 2 yearsiii. The breakeven rate implies what market participants expect inflation to be in the next 10 years, on averageiv. We do think that we will see inflation in 2021 but that it will be isolated pockets of higher prices confined to specific sets of circumstances. We have already seen this happen for some goods, such as lumber and building materials and we expect to see the same when demand increases for items like airline travel and indoor dining. The official definition of inflation, however, is a broad based and sustainable increase in prices. The U.S. consumer has been resilient, but consumer spending has been biased toward upper middle class and high income households who have been less affected financially by the pandemic. The overall unemployment rate remains high at 6.7% and it is significantly worse for those workers with lower educational attainment. The unemployment rate for those 25 years and over with less than a high school diploma is 9% and those with a high school diploma and no college is 7.7% while those with a bachelor’s degree or higher have a 4.2% unemployment ratev. In our view, without a more complete recovery across the entirety of the labor market, it is unlikely that the economy will experience significant inflation.
  2. Slower Economic Recovery – Risk assets are at all-time highs and it appears that good news surrounding vaccines and economic recovery is fully priced as far as valuations are concerned. This leaves little room for error if expected outcomes do not meet lofty expectations. Domestically, the initial vaccine rollout fell short of its goal, having administered only 4.2 million doses by year end versus a target of 20 millionvi. The scientific community is also concerned with new variants of Covid-19, with the UK strain having recently been identified in the U.S.vii and some epidemiologists’ are questioning vaccine efficacy on a newly identified strain found in South Africaviii. We are also concerned about the lingering economic impact that the pandemic may have on small business. While small business optimism has rebounded smartly from the depths of the crisis, many of these firms do not have the financial wherewithal to survive a more prolonged recoveryix.

CAM’s Portfolio Positioning

Our investment strategy has remained consistent in its approach, with a focus on bottom-up fundamentals. It was a challenging year that required constant adaptation to market conditions and the investable opportunity-set at any given point in time. In March and April, we were extremely involved in the new issue market, as concessions rose and high quality borrowers tapped the market to shore up their balance sheets. We were also able to invest in shorter maturities as forced selling caused dislocation across corporate credit curves creating opportunities to buy shorter bonds at yields that were equal or greater to longer maturities. As market conditions normalized throughout the second half the year, we took a more balanced approach between the new issue market and the secondary market. Our focus remained biased toward higher quality credit and sectors of the market that were less levered to the re-opening of the economy and those industries that benefited from more work and leisure time spent at home. As we head into the first quarter of 2021 we continue to favor companies with strong balance sheets and stable credit metrics as the entire market has continued to rally into the New Year. As spreads and yields compress, the incremental compensation afforded from taking additional credit risk has skewed risk-reward to the downside. The “buy the dip” trade has played out in our view and we are scrutinizing the capital allocation strategies of each of the companies in our portfolio. 2021 could be the year were there is a more clear bifurcation between those companies who will exit the pandemic stronger and those who will languish because the business is saddled with too much leverage and unable to effectively compete in the marketplace. As always, preservation of capital will continue to be at the forefront of our decision process.

We wish you a happy, healthy and prosperous New Year. Thank you for your business and continued interest.

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.

i Bloomberg, December 15, 2020 “Freeze to Frenzy, Corporate Bonds Bounce Back”
ii Bloomberg Barclays Global Aggregate Negative Yielding Debt Market Value USD
iii Bloomberg News, January 4, 2021”Treasuries Inflation Gauge Exceeds 2% for First Time Since 2018”
iv Federal Reserve Bank of St. Louis (T10YIE)
v U.S. Bureau of Labor Statistics, December 4, 2020 “Employment status of the civilian population 25 years and over by educational attainment”
vi The Hill, January 4, 2021, “Operation Warp Speed chief adviser admits to ‘lag’ in vaccinations”
vii The Wall Street Journal, January 4, 2021, “Highly Contagious Covid-19 Strain Has Been Found in New York State, Gov. Cuomo Says”
viii Bloomberg, January 4, 2021, “South African Covid Strain Raises Growing Alarm in the U.K.”
ix NFIB, December 8, 2020, “NFIB Small Business Economic Trends – November”