Corporate Credit View

November 7, 2018 by

Post tax reform, investors expected debt supply would decline. Year-to-date, gross debt issuance is on track to be 8% lower than 2017, as companies are working down debt used to fund acquisitions and/or higher interest costs and the new tax law are discouraging debt financed share repurchases. But despite higher rates of EBITDA growth, debt leverage has declined very little. To work their way out of higher levels of debt leverage, companies need growth to continue at these higher rates or shareholders will see less return via curtailed share repurchase programs or, worse yet, dividends.

With debt leverage as high as it is today, credit ratings are at risk of falling if an economic slowdown occurs earlier than expected. We believe about 5-10% of the Investment Grade (IG) market is at risk of falling to high yield (HY) if a recession occurs in the next 12-24 months. This is expected to have a meaningful impact on portfolio performance given the spread widening and potential other costs for investors who hold “index like” portfolios or those with a higher level of credit risk.

Why has leverage increased?

In 2009, the number of firms with more than 3.5x debt-to-EBITDA leverage doubled versus 2005 due to the contraction in EBITDA caused by recessionary conditions. Companies worked to improve their balance sheets by 2012. After this, as economies stabilized (albeit at relatively low growth rates) and debt costs were extremely low, companies added debt at a fairly aggressive pace. The majority of this debt was added to fund: (1) acquisitions in order to reduce expenses and add businesses with growth potential and (2) share repurchase programs to enhance shareholder return (and likely meet performance targets for management teams). Today, there are more firms with leverage in the 2-3.5x range, commensurate with BBB ratings, and fewer firms with leverage less than 1x, which is typically reflective of AA or AAA ratings. Unless interest rates meaningfully increase, we do not expect companies to return to the days of pristine balance sheets.

Exhibit 1: Composition of Debt Leverage for Non-Financial Companies

**Source**: Factset, AAM
(Includes over 350 IG issuers as of 6/2018, excluding Utilities, Financials, Autos and Construction Machinery); Leverage is measured as: Debt/EBITDA(x) and percentages based on issuer count.

Are some industries safer than others?

Looking at the issuers in the market today, excluding those with naturally high leverage such as Utilities, Financials, and companies with Captive Finance companies, we note that the number of issuers with elevated leverage is similar to 2009. While we recognize the increase in BBB rated debt in the marketplace, we note that many firms that have increased debt leverage commensurate with weak BBB ratings (i.e., leverage greater than 3.5x) are consumer related, which should have less cyclical cashflows. That said, these firms are relying on growth and, for some, asset sales to reduce debt over the near to intermediate term. This strategy will be placed at risk if the economy slows materially and/or asset values fall, as we witnessed in October with the drop in the stock market. Therefore, even the most “defensive” credits are not immune to downgrade risk.

Exhibit 2: Highly Leveraged IG Issuers by Sector vs. Prior Cycle

**Source**: Factset, AAM
(Includes over 350 IG issuers as of 6/2018, excluding Utilities, Financials, Autos and Construction Machinery) “Highly leveraged” = firms with Debt/EBITDA exceeding 3.5x

What is the downgrade risk to portfolios?

Today, as we review this list of approximately 60 issuers with elevated debt leverage, we estimate about one third will be downgraded to high yield if a recession were to occur in the next one to two years. Adding Financials to our analysis, we believe the sectors and issuers most vulnerable if a recession were to occur are low BBB rated and, in the REIT, Finance and asset management sectors as well as low BBB rated subordinate debt. Utilities are not likely to be materially impacted. In total, we estimate $225 billion is at risk of falling to high yield with $445 billion as a bear case estimate (which includes low BBB rated subordinated bank debt, Charter, Ford and GM). That would imply 5-10% of the IG market falling to high yield. That is not outsized relative to the total IG or HY market versus prior recessionary periods. S&P states on average 5% of U.S. companies rated BBB have been downgraded to high yield, increasing in recessionary periods with 8% in 2009 and 9% in 2002.*

Exhibit 3: Downgrades from IG to HY ($B)

**Source**: Morgan Stanley (downgrade history), AAM credit team for recession base and bear case estimates

What is the impact?

While 5-10% appears to be relatively immaterial as a percentage of the IG market, it is material to the holder of the securities when they become HY rated especially if that holder is an insurance company.

First, the risk of default meaningfully increases when a bond falls to HY (from an average of 21 bps to 78 bps from BBB to BB respectively per S&P*), which requires an increase in the credit spread to compensate for that risk. In a period of increased risk of default, low quality IG bonds are not the only ones to widen. The correlation in Fixed Income is high, which means widening will occur in all rating categories to various degrees (e.g., A/higher credits may widen 50 bps vs. BBBs that widen 100-300bps). This will have an impact on the market value of the entire Corporate bond portfolio.

As it relates to the bonds that fall to HY, not only will spreads widen due to increased default risk, but they will widen for a period of time due to a supply and demand imbalance (see Exhibit 4). Many investors are forced to sell debt that falls to HY due to portfolio restrictions and/or guidelines. Exhibit 4 shows the typical pattern when an issuer is downgraded to HY. Spreads widen over 300 bps and then tighten from the point of being downgraded as supply and demand normalizes.

Now, what does this mean for a portfolio? Assuming a portfolio holds 10 year maturities with 50% in Corporate bonds, of which 5-10% are downgraded to HY, that would imply a fall in portfolio market value of approximately 1%. The widening in the other A and BBB bonds would add to that market value loss. Diversification in the portfolio is important, and this analysis assumes issuer weightings in the portfolio that are commensurate with the Corporate market as reflected by the Bloomberg Barclays Corporate Index.

In addition to these economics, there are rating agency and/or regulatory implications for insurance companies. Both RBC and BCAR will be negatively impacted by an increase in high yield holdings. This is especially true for companies with Equity holdings, as an increase of downgrades is likely to coincide with a sell off in the Equity market, will impacting capital levels. Moreover, life companies will be subject to higher asset valuation reserve (AVR) balances for HY bonds (exponential). Depending on current capital levels, meaningful downgrades to HY could place a strain on surplus for some insurers, particularly in the P&C space. This would be suboptimal since surplus is being impacted at a time when presumably investment and potentially business related opportunities are more plentiful.

Exhibit 4: Cost of Downgrade: Fallen Angels

**Source**: Morgan Stanley Research, Bloomberg

Is this risk being priced into the market?

Despite recent spread widening, it is clear that the difference in spread between issuers rated BBB vs. high yield is at multi-year tights. We believe now is the time to position the portfolio to avoid credits at risk of being downgraded (see sample of issuers in table below). We have been reducing our BBB exposure and are avoiding credits we believe are at risk of falling to high yield.

Exhibit 5: BBB and BB Spread Differential

**Source:** AAM, Bloomberg Barclays Index as of 10/26/2018 (Corporate Index vs. BB High Yield Index)

Sample of Credits at Risk

*S&P Report: Per S&P, the ‘BBB’ long-term, one-year weighted average default rate (since 1981) is 0.21%, less than a third of the one-year weighted averaged default rate for the ‘BB’ category (0.78%). CreditTrends: When The Cycle Turns: As U.S.’BBB’ Debt Growth Sparks Investor Concern, Near-Term Risks Remain Low Jul 25, 2018 Diane Vazza, Managing Director, New York

October 28, 2018 by

July 18, 2018 by

MARKET SUMMARY AND OUTLOOK

The Investment Grade (IG) Corporate bond market (per Bloomberg Barclays Index) delivered a lackluster -1% total return in the second quarter 2018, with spreads widening 14 basis points (bps). The IG market underperformed the S&P Index which returned 3.4% and high yield (1%). As trade tensions escalated and the USD strengthened, Emerging Markets (debt and equity) underperformed. Corporate bonds with longer maturities underperformed with demand increasing for shorter maturity bonds given the flattening of the yield curve. Spread widening was fairly even across credit ratings, with ‘BBB’s slightly underperforming ‘A’s. Financials outperformed Industrials.

A solid earnings season and optimistic outlook was overshadowed by headlines regarding Italy, trade wars, and M&A in addition to a continuation of weak market technicals. Demand from foreign investors and funds for IG bonds remains lower vs. last year, and supply remains an overhang with higher than expected new issue supply and dealer inventory levels.

One of our credit cycle indicators is raising a cautionary flag given the flattening that has occurred in the Treasury curve. While many are quick to say “it’s different this time,” we understand the curve itself has an effect on investment behavior and economics, which eventually causes risk to reprice. An inverted yield curve is a more serious signal, but one should not ignore a flat curve even though it may take some time for credit spreads to reprice. Looking at points in history when the curve is flattening, spreads are on average about 40 bps wider than the subsequent year.

We expected very pedestrian performance from the IG market this year given the OAS at year end 2017 of 93 bps. While spread volatility has remained fairly low year-to-date (11 bps YTD), the potential for spread widening is higher over the intermediate term. We believe there will be attractive entry points as a result of the increased size of the debt markets, higher debt leverage of companies at this point in the cycle along with the structural changes in the market. Despite starting this year in a fairly defensive position, we are taking the opportunity to reduce our BBB exposure to increase flexibility when spreads widen materially. Historically, spreads for BBB rated credits widen twice the rate of A/higher rated credits.

Performance Summary Year-To-Date
Spreads widened in the second quarter, with OAS 14 bps wider for the market index. The widening related to: (1) headlines associated with mergers and acquisitions (M&A) in sectors such as Telecom, Cable and Media (2) weaker technicals, specifically related to higher than expected new issue supply and dealer inventories particularly on the long end, impacting longer duration sectors such as Railroads and Life Insurance and (3) headlines related to Italy, impacting the Bank sector, subordinated bonds in particular. Sectors that outperformed included: Energy, Consumer related sectors, and more defensive sectors such as Capital Goods and Utilities. Despite these nuances, spreads are wider for all sectors year-to-date.

Source: Bloomberg Barclays Index as of 6/30/2018 AAM (Other – Transportation, Utilities, Capital Goods)

Source: Bloomberg Barclays Index as of 6/30/2018, AAM

Credit Market Fundamentals
Stronger worldwide growth continued to benefit EBITDA growth in the first quarter of the year, allowing firms to slightly deleverage as it outpaced the growth rate of debt.

Source: AAM, Factset data as of 3/31/2018

While the number of issuers with very high leverage (i.e., >4.0x) has fallen from the peak in mid 2016, it remains elevated as does leverage for the group as a whole. While we had expected leverage to improve this year, we believe that may be postponed in light of debt funded M&A. We expect deal activity to remain elevated in growth challenged sectors like Media, Healthcare, Food & Beverage, among others which represent about 20% of the market.

Source: AAM, Factset data as of 3/31/2018 (IG companies; excludes commodities based firms, autos, construction machinery, utilities and financials)

Market Opportunities
The IG market has more than doubled in size and a lot of that growth has come from BBB rated securities, as the exhibit below shows.

Source: Wells Fargo “Q3 Outlook” 6/28/2018

Given the lack of risk premium for BBB rated securities, the level of debt levearge previously discussed and likely pause in fundamental improvement due to leveraging M&A concurrent with late cycle indicators (namely flattening of 2s-10s Treasury curve), we are using this opportunitiy to reduce risk in the Corporate Credit sector, namely BBBs.

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Disclaimer: Asset Allocation & Management Company, LLC (AAM) is an investment adviser registered with the Securities and Exchange Commission, specializing in fixed-income asset management services for insurance companies. Registration does not imply a certain level of skill or training. This information was developed using publicly available information, internally developed data and outside sources believed to be reliable. While all reasonable care has been taken to ensure that the facts stated and the opinions given are accurate, complete and reasonable, liability is expressly disclaimed by AAM and any affiliates (collectively known as “AAM”), and their representative officers and employees. This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. A complete list of investment recommendations made during the past year is available upon request. Past performance is not an indication of future returns. This information is distributed to recipients including AAM, any of which may have acted on the basis of the information, or may have an ownership interest in securities to which the information relates. It may also be distributed to clients of AAM, as well as to other recipients with whom no such client relationship exists. Providing this information does not, in and of itself, constitute a recommendation by AAM, nor does it imply that the purchase or sale of any security is suitable for the recipient. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment and extension. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

April 18, 2018 by

Market summary and outlook

The market has been running at a nice pace for over a year; therefore, recent volatility has felt rather uncomfortable. The Investment Grade (IG) Corporate bond market (per Bloomberg Barclays Index) delivered a lackluster -2.3% total return in the first quarter 2018, due mostly to higher Treasury yields, with spreads widening 16 basis points (bps). Risk assets outperformed the IG market, as the S&P Index returned -0.8% in the first quarter, high yield -0.9%, and Emerging Markets -1.5%. Corporate bonds with longer maturities underperformed. Spread widening was fairly even across credit ratings, leaving ‘BBB’s to outperform ‘A’s due to their yield advantage. Industrials and Utilities outperformed Financials.

Volatility in the markets resulted in less buying from foreign investors and primary market dealers, with corporate bond inventory levels falling to a low last seen in 2015-2016 during the commodity related sell off. Moreover, the rise in LIBOR has increased hedging costs, reducing the attractiveness of US credit for foreign investors. Demand has also waned from fund investors and cash rich corporations post tax reform. Despite new issue supply that is running about 10% below last year’s pace, the reduction in demand was sufficient to push spreads wider especially on the short end of the curve.

Our outlook for 2018 is predicated on fundamental improvement and continued demand for corporate credit. Fundamentals are performing as expected, and our credit cycle indicators remain in check. Revenue and cash flow estimates are being increased, management is forecasting strong capital spending post tax reform, debt leverage is projected to remain stable and should decline as corporate yields increase. Importantly, we do not expect companies to increase debt leverage to repurchase stock. We expect market technicals to improve over the near term with the tightening of supply (lower level of dealer inventories and a projected decrease in net new supply vs. 2017). The risks to our outlook are: (1) slower than expected GDP growth (2) a flattening or inversion of the yield curve (3) reduced demand for IG corporate bonds. Thus far, we have had pressure from risk #3 and some concern in regards to risk #1 given the disappointing economic data in Europe.

Performance summary year-to-date

Spreads widened in the first quarter, with OAS 16 bps wider for the market index. The widening related to: (1) spread widening related to new issues or headlines associated with mergers and acquisitions (M&A) in sectors such as Cable, Health Insurance, Consumer Products and Food and Beverage that face secular challenges impacting growth. We have been expecting these companies to look for opportunities to use their underleveraged balance sheets to acquire assets or be acquired; (2) selling and reduced demand for short duration corporate credit given the lack of relative value for corporations and foreign investors given tax reform (i.e., companies no longer need to hold trapped cash overseas) and the increase in LIBOR and affect on hedging costs. That selling impacted sectors like Banks that have more bonds in the short end of the maturity curve. (3) headlines associated with policy changes (i.e., tariffs and trade which affected sectors like Autos, or unexpected changes to FERC regulated pipelines that affected sectors like Midstream). Only two sectors registered positive excess returns versus Treasuries, Packaging and Wirelines. Wirelines outperformed due to creditor friendly actions taken by AT&T.

Source: Bloomberg Barclays Index; AAM (Other – Transportation, Utilities, Capital Goods)

Source: Mizuho Syndicate report 1Q2018

Credit market fundamentals

Indicators monitored by AAM continue to be supportive for corporate credit. Bank lending standards continue to loosen, nonbank creditor data has improved, capital markets (leveraged loans, high yield) remain wide open and attractive to borrowers, and the yield curve remains upward sloping. That said, yields (especially on the front end) are increasing and while higher interest expense is not a burden for an Investment Grade company, we expect higher yields will start to pressure the financial performance of leveraged borrowers (consumers and corporations). Tax related savings and higher revenues due to the expectation for continued strong global growth are expected to offset this cost for the average borrower over the near term.

That said, generally in an environment of higher growth and interest rates, companies should not be as apt to increase debt leverage especially to repurchase shares. For the first time since the recession, companies are facing higher yields to refinance maturing debt.

Difference in the Cost of Maturing Debt vs. Refinancing Rates

Source: Bloomberg Intelligence, BVAL

Given the equity market rally, reduced tax rate for corporations, and higher Treasury yields, the economic advantage of raising debt to fund share repurchases is starting to look less attractive. As shown in the exhibit below by the dark blue line, the spread between earnings and after tax borrowing yields is much tighter today. We recognize debt leverage at the corporate level is high, and have written on this topic extensively, but looking forward, we believe companies are more incentivized to reduce debt leverage.

Source: Bloomberg, AAM (Corporate Yields calculated using Bloomberg Barclays Corporate Index OAS plus 10 year Treasury yield multiplied by (1-corporate tax rate); Earnings Yield is for S&P 500)

Market Opportunities

The Corporate market lacked value at the start of the year, thus we have welcomed recent spread widening. With the increased M&A, we are (once again) taking advantage of new issues to fund corporations we believe are better positioned (e.g., General Mills, CVS).

Aside from M&A headlines, trade related headlines have caused extreme equity market volaitiliy, directly affecting sectors like Autos and indirectly affecting the entire market as investors demand higher credit spreads to compensate for it. We are taking advantage of opportunities where we believe the market is being too punitive. One example is the Auto sector where we are more positive than the market on both fundamentals and valuation. Check out our video from the Chicago auto show for more details on the sector’s fundamental outlook. https://aamcompany.com/insight/aam-at-the-chicago-auto-show/

Lastly, to remain largely neutral to the Corporate sector given lackluster valuation, we are funding these ideas with credits in sectors that have outperformed (e.g., Wirelines, Aerospace/Defense). We continue to believe 2018 will be one where security selection drives returns, as the market overall delivers fairly pedestrian performance.

Source: Bloomberg Barclays, AAM as of 4/6/2018

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December 22, 2017 by

2017 Summary

Markets surpassed expectations in 2017, supported by synchronized global growth, low volatility, and the prospect of tax reform. The Investment Grade (IG) Corporate Credit Market, as represented by the Bloomberg Barclays Index, generated a return of over 3% in excess of Treasuries. The high yield default rate improved from 6% to 3%. Moreover, after two years of rating downgrades to high yield outpacing upgrades to IG, the trend reversed in 2017. All IG sectors performed well, especially Energy, Basic Materials, and Insurance. Companies took advantage of the strong demand for IG bonds, issuing a record breaking $1.3 trillion. Revenue and cash flow growth accelerated in 2017, due to increasing commodity prices, interest rates, and worldwide growth. Companies took a pause from merger and acquisition (M&A) activity, waiting for policy clarity from the new Administration. This activity started to pick up later in the year. Median debt leverage for IG companies declined in 2017, driven mainly by commodity related firms, as leverage excluding commodity related sectors remained essentially unchanged.

Source: FactSet as of 9/30/2017, AAM (317 IG credits, excluding financials, autos, construction machinery)

2018 Outlook

For 2018, we expect continued worldwide growth to support revenues with corporate tax reform in the US enhancing cash flows for the majority of IG companies. Those with domestic focused operations are expected to benefit the most from tax reform, as they have higher effective tax rates. Importantly, while we expect most of the benefits to accrue to equity holders, there will be companies that will use the tax savings to deleverage (i.e., Pharmaceuticals). We will monitor the potential negative consequences of this reform, such as the reduction in financial flexibility for growth challenged, highly leveraged companies and/or consumers in high property and income tax states or conversely, higher than expected inflation causing the Federal Reserve to raise rates more aggressively to dampen growth.

We expect Sales growth to be around 5% with EBITDA growth approaching 10% on average in 2018. Capital spending is expected to return to the levels experienced before the commodity correction (6%+). We expect M&A activity to pick up meaningfully next year, as technology and other catalysts drive companies to vertically or horizontally consolidate. Similar to 2017, we are not expecting a material reduction in debt leverage despite positive fundamental trends due to the low cost of debt relative to equity. Given the number of companies with elevated debt leverage relative to other cycles, the credit market remains vulnerable to an unexpected shock to revenues or cash flows. This is not only an IG issue but a high yield and loan market issue as well given the percentage of credits rated B3 and lower. Due to the positive top line trend, our fundamental outlook for the corporate sector overall is stable with the most dispersion in non-financials.

The demand from investors for corporate credit remained very strong in 2017. Inflows into IG bond funds and ETFs was two to five times higher than the annual flows of the last three years respectively. In addition, demand from foreign investors remained elevated, as yields net of hedging costs remained attractive in USD denominated IG bonds. For 2018, we believe corporate credit will remain attractive to investors seeking yield (pension, insurance), but with higher hedging costs, increased supply of alternatives related to QE unwinds, and the likelihood of lower prospective total return given the expectation for higher rates, the risks are skewed to the downside. We expect credit curves to flatten, with the short end underperforming.

Developed Market fixed income supply to increase meaningfully in 2018

Our expectation is for volatility to remain historically low in 2018, with little movement in the average option adjusted spread (OAS) for the market, generating projected excess returns vs. Treasuries in IG corporate credit of between 75-125 basis points. Corporate bond spreads vs. Treasuries are ending 2017 at very low levels historically, especially for higher rated credits, reflecting the expectation for low defaults and volatility. In this environment, we are prioritizing fundamentals and credit selection. We believe identifying idiosyncratic risk at the sector and especially credit level will be very important to portfolio returns in 2018.

The sectors we believe will outperform include: Metals & Mining, Diversified Manufacturing, Wireline, Supermarkets, Pharma, Tobacco, Independent Energy, Midstream, Rail, Electric Utility, Natural Gas, Life Insurance, and P&C Insurance. Those we believe will underperform the market overall include: Health Insurance, Technology, Integrated Energy, Consumer Products, Food/Beverage, Healthcare, Auto, Cable, Media, and Chemicals.

Written by: Elizabeth Henderson, CFA

Director of Corporate Credit

November 2, 2017 by

Market summary and outlook

The Investment Grade (IG) Corporate bond market delivered a 1% total return in the third quarter 2017, with spreads tightening 7 basis points (bps). Risk assets outperformed with the S&P Index returning 5% in the third quarter, high yield 2%, and Emerging Markets 2% as well. Corporate bonds with longer maturities and BBB ratings outperformed using the IG Index per Bloomberg Barclays. This is a continuation of the performance witnessed in the first half of the year.

We continue to see strong demand from bond funds for investment grade securities, and foreign buying of USD IG debt remains a source of demand despite the less attractive yield advantage (net of hedging costs). New issue supply was higher than expected in the third quarter. Except for a brief period of spread widening in August related to rising geopolitical risk and falling expectations for tax reform, spreads have consistently moved tighter this year. We do not see warning signs related to the credit cycle. That said we are watching closely since (1) the growth in debt is concerning if economic growth starts to disappoint, and (2) risk premiums are low, which has historically masked bad decisions by management teams and financial lenders.

Despite lackluster valuations, we have a neutral opinion on the IG corporate sector, expecting technicals to remain supportive and fundamentals relatively stable over the near term given policy related uncertainty, improving overseas growth, and favorable lending conditions. Margin pressures such as rising labor costs and/or disappointing growth remain a risk given the elevated level of debt leverage and size of the credit market, BBB rated securities specifically. Moreover, we expect companies to resume M&A activity over the near term. Tactically, we are maintaining flexibility in portfolios given very tight spreads to add opportunistically when spreads widen.

Source: Bloomberg Barclays, AAM as of 10/24/2017

Performance Summary Year-to-date

Spreads continued to tighten in the third quarter, with OAS 21 bps tighter year-to-date. Commodity and Financial sectors outperformed in the third quarter with spreads widening in the Cable, Media and Supermarket sectors. This widening was related to secular challenges and the event risk that results, with the best example being Amazon’s purchase of Whole Foods and what that means for grocers like Kroger. We have been investing with these themes in mind, reflected in recent presentations on electric vehicles and the cable/media sectors.

As shown below, all broad sectors have contributed to very strong performance in the Corporate market as of the end of the third quarter.

Source: Bloomberg Barclays Index (as of 9/30/2017), AAM

Credit fundamentals

Credit metrics have been largely stable in 2017. Revenue growth has improved for most sectors versus last year driven largely by the strength in economies like Europe and China as well as higher commodity prices. We are not seeing debt leverage come down meaningfully, and it remains a concern of ours, but changes related to tax reform may incentivize companies to have less debt in their capital structure. One headwind for leverage is our expectation that M&A will increase, typical when volatility is low and sentiment is high.

Source: Factset, AAM as of 6/30/2017 (Data reflects IG issuers, excluding Financials, Utilities)

Credit Sector indicators

We track indicators statistically proven to forecast spread widening. One is the Senior Loan Officer Survey. As banks tighten lending standards, it tightens the credit markets. We were concerned in 2014 when we saw that trend, but that reversed in 2016. Thus far in 2017, lending standards have remained favorable. This message is consistent when we look at the survey data provided by the non-banking sector, namely the Credit Managers Index. That Index has also registered data consistent with an “expansionary” cycle. Lastly, the other indicator that has proven to be a reliable indicator is the shape of the Treasury yield curve. That is flattening, but remains upward sloping, which is good for the credit market. However, it is something we are watching closely as Treasury yields have become more volatile given the uncertainty surrounding the Federal Reserve Chair appointment, QE in Europe as well as stimulus provided by tax reform.

Source: AAM, Barclays, Fed

Technical Support

While the Federal Reserve may be on a path to raise rates, the ECB and BOJ remain accommodative. The ECB surprised investors this week by extending its corporate bond buying program. Monthly purchases from the ECB and BOJ will continue to take liquidly out of the system even with the Fed compressing its balance sheet. This strong technical keeps us investing in corporate credit despite lackluster valuations. We remain watchful of signs of inflation, which would change this dynamic.