By Ryan O’Malley, Sage Advisory
As the dust begins to settle following the extreme volatility seen in the second quarter of 2020, the corporate bond market has revealed opportunities. At Sage, we favor the communications, energy, and high-yield sectors as we believe they offer solid credit fundamental trends along with strong relative value.
The fourth cheapest sector in the Bloomberg Barclays US Corporate Bond Index with an option-adjusted spread (OAS) of 154 bps, the communications sector has a number of liquid issuers with improving balance sheets and strong cash flow generation, such as CBS/Viacom and AT&T. These issuers have also benefitted from the increased demand for at-home entertainment and data as many consumers have eschewed brick-and-mortar retail and movie theaters for more at-home friendly options.
Corporate Bond Sector Spreads
Source: Bloomberg Barclays Indices
Energy is still the cheapest sector in the Bloomberg index after suffering an extreme dislocation during volatility in April. As the price of WTI oil has recovered nearly 100% from April lows to $42.16 currently, better capitalized companies are taking advantage of robust demand for investment grade paper and tendering for short-maturity, high-coupon bonds to decrease interest expense and improve their balance sheets. At the same time, global macro fundamentals have buoyed the outlook for commodities while supply has decreased dramatically, creating a more sustainable market for drillers that have the financial resources to take advantage of these favorable financing conditions. The following graph illustrates the slowdown in drilling activity, which has supported oil prices.
Baker Hughes U.S. Total Rig Count Index
Sage continues to see value in the high-yield sector of the corporate bond market. The ratio of OAS offered by high yield compared to the overall corporate market is nearly 3.8x. This is close to the post-crisis high of 4.1x seen in June 2020. This is nearly two standard deviations higher than the median ratio since 2009, implying that we are still a range that is cheaper than nearly 95% of observations since the Great Financial Crisis.
Option-Adjusted Spread Ratio of High-Yield vs. Investment Grade Corporate Bonds
(Lines Represent One and Two Standard Deviations)
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