Strong Fundamentals, Demand Drive Investment-Grade Corporates

Investors’ search for yield and income continues. We believe investment-grade corporate bonds have a role to play by potentially offering attractive additional yield and relatively low volatility versus higher-quality government bond segments. 

We recognize that valuations are elevated; however, as we look into 2022, we believe there are two key drivers that may be underappreciated providing opportunities in investment-grade corporates.

The first key driver is that corporate fundamentals continue to improve.

Corporate leverage has fallen as issuer profits have recovered.

Corporate debt loads have also started to decrease on a year-over-year view after a large jump in 2020 as issuers sold new bonds. This is further lowering leverage.

Credit rating agencies are responding to the improving fundamentals with more upgrades. Beginning in the second quarter of 2021, the number of upgrades within the U.S. investment-grade corporate sector has been greater than the number of downgrades. We see this trend continuing into 2022.

The second key driver is that market technicals have been more supportive than expected.

In terms of supply, we expect new bond issuance supply to be reasonably stable in 2022, which is a positive versus the large increases experienced in 2020.

Less well understood is the demand side for investment-grade corporates. Buyers outside the U.S. have been drawn to the market by the attractive yields after converting into their local currency. This is particularly true relative to the still-negative yields on many high-quality non-U.S. government bonds.

So how and where do we find value and express our views? We see potential value in industries including banks and communications. We favor intermediate maturities over longer-term bonds because of their better historical risk-adjusted returns.

We also have a Fed that is removing policy accommodation. Historically, credit spreads have typically tightened at the beginning of a Fed hiking cycle, which is an encouraging sign for 2022. It is usually later in this cycle where credit spreads widen, so that is something we are taking into consideration for 2023.

We expect the supportive technical and fundamental trends to continue well into early 2022. As a result, we believe investment-grade corporates may provide a solid investment choice.