Indexology^® Blog

The last few days of February had many wondering whether corporate bond indices would end up closing positive or negative for the month.  The majority of indices closed up for February, but not by much.

Higher-quality corporate bonds, as measured by the S&P 500® Bond Index, posted a 0.83% total return for February and returned 1.18% YTD.  The breakdown between investment grade and high yield was all positive, as the S&P 500 Investment Grade Corporate Bond Index returned 0.79% for the month and 1.22% YTD, and the S&P 500 High Yield Corporate Bond Index returned 1.39% for the month and 0.94% YTD.

The S&P U.S. Investment Grade Corporate Bond Index returned 0.68% for February.  U.S.-issued bonds, as measured by the S&P U.S. Issued Investment Grade Corporate Bond Index, returned 0.81% for the month.  Meanwhile, foreign-issued U.S. dollar bonds, as measured by the S&P U.S. Foreign Issued Investment Grade Corporate Bond Index, returned 0.28% in February, and since it accounts for 25% of the S&P U.S. Issued Investment Grade Corporate Bond Index, the drag down effect for February hurt the overall return.

In the high-yield category, all but CCC and lower and leveraged loans pulled off positive returns for the month.  In February, the S&P 500 High Yield Corporate Bond Index returned 1.39%, while the broader S&P U.S. High Yield Corporate Bond Index returned 0.40%.  Leveraged loans, as measured by the S&P/LSTA U.S. Leveraged Loan 100 Index, underperformed and returned -0.21% for the month and
-0.64% YTD.  After returning -2.75% for 2015 and losing -0.42% in January, leveraged loans are still bearing the brunt of concern over lower credits.

The yield-to-worst of the S&P/BGCantor Current 10 Year U.S. Treasury Index ended the month 18 bps tighter, at 1.75%.  Continued concerns over commodity prices and the pace of economic recovery both domestically and internationally has kept rates lower.  China continues to be a question mark, as the most recent PMI reports point to a deepening slowdown.

Exhibit-1: Total Rate of Return Performance

Source: S&P Dow Jones Indices LLC. Data as of Feb. 29, 2016. Past performance is no guarantee of future results.  Table is provided for illustrative purposes.

On Feb. 24, 2016, the People’s Bank of China announced that offshore commercial banks, insurance companies, securities companies, fund management companies, and pension funds are free to invest in China’s interbank bond market.  Previously, foreign investors could only access China’s onshore bond market through a QFII or RQFII quota.  The removal of the quota system was first implemented for foreign central banks and sovereign wealth funds in July 2015. This new announcement will further encourage the inflows from foreign investors.

In addition, as China’s currency is now part of the International Monetary Fund’s special drawing rights basket, broader use of the renminbi in trade and finance is anticipated.  The global demand for renminbi assets is also expected to continue to grow.

As tracked by the S&P China Bond Index, China’s onshore bond market stood at CNY 38.9 trillion (USD 5.95 trillion) as of Feb. 24, 2016.  The S&P China Bond Index rose 8.05% in 2015 and was up 0.64% as of Feb. 24, 2016 (see Exhibit 1).  The yield-to-maturity was at 3.08% with a modified duration of 4.02 as of the same date.

Exhibit 1: Total Return Performance of the S&P China Bond Index

Amidst continuing anxiety over financial markets, the U.S. economy turned in some good numbers last week. Fourth quarter GDP was revised upward to 1% real growth from 0.7% with consumer spending up 2.0% at seasonally adjusted real annual rates.  Surveys of forecasters had expected growth to be scaled down to 0.4%. Final sales — GDP excluding inventories – was up at a 1.2% real annual rate.  Residential investment was the stand-out performer, rising at an 8% real annual rate.  Personal income and consumption in January — both up at a 0.5% month pace before adjusting for inflation — beat forecasters’ expectations. Orders for durable goods rebounded strongly from a weak December with strong 5% month on month growth as the non-defense capital goods component was up 3.9% on the month.

Attention will turn to what’s next – the employment report scheduled for March 4^th.  One consistent aspect of this economic expansion has been the low number of weekly initial unemployment claims. They continue to run well below 300,000 — the level usually seen as the border between solid growth and possible slowness. Initial claims – the number of people newly out of work filing for unemployment insurance are often cited as a predictor of the unemployment rate. The first chart shows this pattern. Early published forecasts* look for payrolls to rise by about 200,000; much better than the disappointing 151,000 in January but not quite at the recent average of 230,000 per month.  Forecasts suggest the unemployment rate will remain at 4.9%.  Anxiety about the markets will remain, even though both the S&P 500 and oil have so far held above their recent low set on February 11^th.

*forecast by Marketwatch

As February comes to an end, so might be the commodity catastrophe.  Although the S&P GSCI Total Return lost another 3.2% in the month (through Feb. 26, 2015,) bringing the year-to-date performance down to -8.2%, half of the 24 commodities in the index were positive for the month. Further, at least one commodity from each sector gained in February, and the majority of sectors, 3 of 5, were positive for the month.

The S&P GSCI Precious Metals continue to lead in 2016, adding 8.7% in Feb., for a YTD gain of 14.2%. This is from gold’s gain of 15.1% YTD, making it the best performing commodity in the index for the year, and also for the month, up 9.3% in Feb. However, it’s not the best performing commodity for the month by much with zinc adding 8.1% and sugar up 7.2%.

Zinc’s gain contributed to the positive performance of 3.1% in industrial metals for the month plus all the constituents in the sector gained except nickel. There is tightening supply in the metals, especially in zinc, copper and lead, with the latter two, showing positive roll yields in February.

All three commodities in livestock were also positive in the month for a sector return of 1.5% MTD. Inventory increases in lean hogs reduced their monthly gain to just 24 basis points but the commodity is still posting a YTD gain of 8.7%, making it the third best performer of all the commodities in 2016 – only behind gold and zinc.

The agriculture sector did not fare as well in February, losing 3.3%, despite the gains in the softs. The USDA (United States Department of Agriculture) forecasted increased corn plantings and grain production that hurt the sector. However, sugar had its best day since 1993 from the volatile El Nino weather predicted that may lower supply in the coming year. If this weather pattern continues to reduce crop yields like in historical El Ninos, it may benefit all the prices in the sector.

At the same time, the El Nino is harmful to the performance of natural gas. It was the worst performing commodity for the month with a loss of 24.3%, bringing the S&P GSCI Natural Gas to its lowest level on Feb. 25, 2016 since March 24, 1999, almost 17 years. Since the world production weight is relatively small, the loss didn’t contribute significantly to the sector that lost 6.6% for the month. Petroleum was down 5.3%, despite gasoil’s 3.8% gain, but (WTI) crude oil gains of the magnitude witnessed during the month have only happened around other bottoms. 

Ex-energy, commodities are positive for the year.  The S&P GSCI Non Energy Total Return is up 14 basis points in 2016, finally reaching a turning point after its near 20% loss in 2015. That is pretty good considering the -8.2% loss year-to-date for the S&P GSCI.

It is optimistic given tightening inventories in industrial metals, the weather hurting crop yields in agriculture and the sporadic but big oil gains. In particular, it might be most promising if oil rises since if oil rises, it helps all other commodities.

As of Feb. 26, 2015, the U.S. corporate bond market was valued at USD 8.3 trillion.[1]  For comparison, that’s larger than the GDP of Germany, France, and the U.K. combined.  Exhibit 1 details the growth of the U.S. corporate debt market since 2009, showing annual issuance amounts for both investment-grade and high-yield debt.  Since 2012, there has been USD 1.3 trillion[2] of U.S. high-yield corporate debt issued—more than the total amount issued in the prior 10-year period (2002-2011).

Given the low interest rate environment and the increased demand for yield, many U.S. corporations have taken advantage of the opportunity to borrow at lower costs.  What is interesting is how increased borrowing may not necessarily contribute to long-term growth.  Rather than investing in assets or technology, many companies used the proceeds from debt issuances to pay dividends or support buyback programs.  As evidence, dividends paid out by companies in the S&P 500^® in 2015 amounted to the highest proportion of their earnings since 2009.

Further, using the constituents of the S&P 500 Bond Index, measures of debt relative to cash flows are at levels not seen since 2008 (see Exhibit 2).

Also noteworthy is the amount of U.S. corporate debt that is scheduled to mature in the next five years.  Recent reports from rating agencies state that as much as USD 4 trillion[3] in U.S.-rated corporate debt is set to mature through 2020.

Of the USD 3.7 trillion of corporate debt tracked by the S&P 500 Bond Index, over USD 1.5 trillion (approximately 40%) is set to mature through 2020 (see Exhibit 3).

While the past six years have been conducive for corporate debt issuance, the current environment of easy monetary conditions may not continue.  As seen with the recent turmoil with high-yield debt, the market’s ability or willingness to support debt refinancing is not always present.  As credit concerns escalate, corporations may face the possibility of increased funding costs or limited refinancing options.

[1]   Source: SIFMA

[2]   Source: SIFMA

[3]   Source: Standard & Poor’s Ratings Services Credit Services Ratings & Research (RatingsDirect^®)