Corporate bond bonanza poses a threat to the market and some opportunities Corporate bond bonanza poses a threat to the market and some opportunities Corporate bond bonanza poses a threat to the market and some opportunities

Corporate bond bonanza poses a threat to the market and some opportunities

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  There is a fast deterioration in the lower-rated high-grade bond space that is becoming explosive. To limit volatility in one's portfolio is essential to pick high-quality assets and to measure duration carefully. Expect numerous downgrades as corporates gear up their balance sheet to lock in record-low interest rates.


Are you surprised by the volatility in the equity market? Please, don't!

There is plenty of reasons why volatility is high and will continue to stay that way: coronavirus, US election, trade tensions and an economic recession to mention a few. 

Don't worry; it may yet not be the beginning of the end. However, a competent investor will need to listen to what the market has to say, to better plan for the future.

The system is over-leveraged. The year has not ended yet, and we already see a record high investment-grade bond issuance compared to previous years (refer to the chart below). Companies are ramping up their borrowing through the bond market to take advantage of ever low-interest rates. This aggressive new bond issuance trend doesn't play in favour of your portfolio. What is happening is that companies are gearing up their balance sheets and deteriorating their overall ability to stand economic downturns. And, if it weren't enough, we are at the beginning of an economic recession already.

Source: Saxo Bank.

It may be the right time to reconsider your equity portfolio, take profit in some of your position and look towards safer investments.

Bonds are an excellent instrument when it comes to protecting an investor from market fluctuations. When an investor buys into a bond, he locks in a specific return if held till maturity. If sold before maturity, however, there is the risk that a bond can be worth less than when one purchased it. This is the reason why, if you are switching some of your equities to enter in bonds, you want to be careful to the maturity you are choosing. If the nominal bond prices fall, you may need to hold on that bond until maturity. That's why for the majority of investors, it makes sense to look at shorter maturities and to wait out until the principal has been paid.

The good news is that at the moment there is plenty of US investment-grade corporate bonds offering an interesting pick up over the treasuries. Which one should an investor choose?

Well, it depends on what you are trying to achieve. Depending on which type of bond are you choosing, you may get a different result. As you can see from the chart below, US Aaa corporate bonds provide better returns even in circumstances of high volatility. Lower rated investment-grade bonds, on the other hand, tend to be more volatile.

Source: Bloomberg.

There is a reason behind this trend: lower-rated investment-grade companies are the ones that in the past couple of years have been taking on more debt. Thus, they are also the most vulnerable to market shocks because they could be downgraded into junk faster than expected.

Credit erosion in the lower-rated spectrum may turn into downgrades sooner rather than later. Volatility in the market continues to be high, which means that in the long run, there will be limited funding opportunities. Corporate America will find out at its own expenses the difficulties to manage massive cost structures.

It is therefore correct to think that higher rated corporate bonds create a better buffer against volatility, but there is some bad news. They are expensive! And they will probably become more expensive as the Fed continues buying into this space (please refer to “Near-zero US Treasury yields and inflation: an explosive cocktail”).

The good news, however, is that often a downgrade is already priced in lower investment-grade bonds. This means that if the security is downgraded, the price of the bond will not fluctuate as much.

In conclusion, in the investment-grade corporate bond space, there are obvious risks. The challenge is to understand which risk can be acceptable in your overall investment strategy. Even though the lower-rated investment-grade space is vulnerable, it can still provide a nice upside if held until maturity. Better rated IG bonds, on the other hand, can be useful to limit one portfolio's volatility.

Buying a bond is very much like buying a pair of shoes. You need the right size, but you can choose from many different colours.

My right size in maturity is up 4 to 6 years, while my favourite colour is BBB/baa3, what is yours?

Please have a look at the most interesting investment-grade US corporates that we believe are available out there; it may give you some inspiration. If you are a Saxo Bank client click here, if you have a Demo account click here.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
- Full disclaimer (https://www.home.saxo/en-mena/legal/disclaimer/saxo-disclaimer)


Boulevard Plaza, Tower 1, 30th floor, office 3002
Downtown, P.O. Box 33641 Dubai, UAE

Contact Saxo

Select region

UAE
UAE

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

Saxo Bank A/S is licensed by the Danish Financial Supervisory Authority and operates in the UAE under a representative office license issued by the Central bank of the UAE.

The content and material made available on this website and the linked sites are provided by Saxo Bank A/S. It is the sole responsibility of the recipient to ascertain the terms of and comply with any local laws or regulation to which they are subject.

The UAE Representative Office of Saxo Bank A/S markets the Saxo Bank A/S trading platform and the products offered by Saxo Bank A/S.