CreditSights: The Week In Credit
The market technicals and upcoming seasonal factors augur well for a solid performance from corporates into year-end and we expect the bid to continue into the typical January frenzy. The troubling question of valuation aside, there seems little indication that the 14-month rally in corporate bonds is running out of steam and we are returning to a recommended overweight stance on the corporate market overall.
There is no denying it was far easier to recommend corporates 12 months ago when spreads were more than twice as wide and our valuation models were taking on a bird-like quality (cheap, cheap). We find pricing to be extremely tight when you compare the relative improvement in credit fundamentals with the relative movement in spreads. But we are of the view that in investing it is necessary to keep one eye on the fundamentals and one eye on the market psychology. A market may be theoretically rich when its pricing diverges from historical relationships with broader economic data, but it is only practically rich if investors refuse to buy into it at current levels. There has been much evidence to suggest this is currently not the case.
The 2003 annual tally is already $410 billion for investment-grade bonds and $160 billion for high-yield deals. This combined $570 billion of supply already stands second only to 2001's full-year total of $632 billion. Beyond the evident demand for new issues, the ongoing appeal of the corporate bond sector can be seen in the willing bid for new or infrequent names which offer portfolio diversification and often get priced very aggressively considering their liquidity and credit stories.
The degree to which this will continue into December in preparation for the bulk of new-year positioning depends upon longer-term factors that are more difficult to determine. Although it would be overly optimistic to declare that all will be plain sailing, the last six months has been the first period since March 2000 that the U.S. economy has not been hamstrung by a major impediment. The economic momentum that has been released in the absence of these constraints is palpable and should continue into 2004. Yet we have a Federal Reserve that sees few bottlenecks given the low capacity levels that we are coming off and therefore minimal inflationary pressure and little reason to choke off a recovery that still has much work to do to address the recent job losses. We believe the overall perception that the Fed can maintain an accommodative stance well into 2004 is likely to drive continued allocation to the fixed income sector.
Analysis by CreditSights, Inc., an independent online credit research platform. Call (212) 340-3888 or visit www.CreditSights.com for more information.