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In the depths of panic over the COVID-19 pandemic, markets seized as investors rushed out of risk assets and into cash and U.S. Treasuries. At the epicenter of the slide was an effort to sell any asset that could be liquidated.
Equity markets declined sharply as uncertainty over earnings and liquidity made visibility over valuations difficult. Credit markets experienced a painful unwinding of leverage that was felt across a broad swath of instruments. Investment grade, high yield and emerging credit all experienced widening credit spreads and price declines at an unprecedented pace as did other parts of fixed-income markets, including mortgages, commercial mortgage-backed securities and municipals.
Within credit, high-yield bonds suffered the most as investors worried about the impact from the economic shutdown on low-quality borrowers. Sellers outnumbered buyers and bid-ask spreads approached 250 basis points (bps). The bid-ask spread is essentially the difference between the highest price a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept.
Among sectors within high yield, energy experienced the sharpest contraction as the pandemic’s impact was exacerbated by falling oil prices, when what began as an expended demand shock was compounded by Russia’s lack of cooperation with OPEC in cutting oil production, and then Saudi Arabia’s reaction to increase its own production punitively. Energy securities posted their worst quarter on record, losing nearly 50% over the course of three months.
Similar to the pullback experienced within high yield, investment-grade credit spreads were volatile in the first quarter of 2020. Credits spreads measure the difference in yield that a corporate bond offers relative to a U.S. Treasury security with a comparable maturity. The spread is meant to compensate investors for the additional risks. From the start of the year to the end of the quarter, investment-grade credit spreads, as measured by the Bloomberg Barclays U.S. Corporate Bond Index, widened massively from 93 bps to 272 bps, a level not seen since the 2008–2009 financial crisis. Intra-quarter, the spread on the index reached 373 bps before rallying into the end of the first quarter.
Despite the volatile first quarter, U.S. Treasury securities performed well as yields fell and investors sought out safe havens. From the beginning of the year to the end of March, the yield on the 10-year U.S. Treasury fell 125 bps from 1.92% to 0.67%, while the yield on the 2-year U.S. Treasury fell 132 bps from 1.57% to 0.25%. This was driven by the Fed cutting rates twice in March, ending the quarter with a target range of 0–0.25%.
As the stock market sank into a bear market at the fastest pace in history, the Fed dramatically increased efforts to save the economy, promising to do “whatever it takes” to ensure liquidity. Fiscal policy followed suit and Congress quickly passed the $2.2 trillion CARES Act. The equity and fixed income markets rallied on the news.
Ivy Securian Core Bond Fund Portfolio Managers Tom Houghton and Dan Henken noted that policymakers recognize this is a multi-pronged challenge — a correction in valuations, a liquidity squeeze, a collapse in energy prices, an upturn in defaults stemming from cyclically high corporate leverage and COVID-19-specific shocks.
In aggregate, the policy response has exceeded the actions taken during the Global Financial Crisis.
The Fed’s intervention consisted of several programs, including:
The Fed is poised to buy various asset classes, except equities, and has made clear progress in opening the corporate debt market, which had been illiquid until it stepped in. Purchases by the Fed have brought credit spreads lower and normalized fixed income trading.
The Fed’s moves have also unleashed large amounts of new issuance. Despite the substantial increase in volatility over the past few months, investment-grade bond supply increased as companies rushed to issue longer term debt to term out shortterm funding, as well as ensure liquidity through this difficult economic period. In fact, as markets loosened starting March 23, investment-grade bond issuance in the quarter ended up 49% relative to the first quarter of 2019. For the month of March, issuance was up 129% year over year and surpassed the prior monthly issuance record from May 2016. In high yield, issuance rose in the quarter although not to the same extent as investment grade.
Lastly, economists are struggling to get a handle on the length and depth of a recession during a pandemic as well as the impact of a forceful policy response. Projections for gross domestic product vary widely for second quarter 2020 with estimates ranging from 9% to -40% annualized growth, and full-year 2020 estimates of -1% to -6%.
While the U.S. job data shows how deep the incoming recession may likely be, some investors are hoping that additional stimulus from the Trump administration will further cushion the blow. It appears the market is looking broadly through a flattening of COVID-19 cases and the shortterm economic damaged caused to a recovery starting in the latter half of 2020. In April, we saw the best one-month equity return in decades, and the best two-week period since the depths of the Great Depression. Broad market increases again followed in May. With the “Great Lockdown” beginning to wind down, as investors, we need to balance this view with the reality that we still need to get through the earnings hole.
From the outset, we have been framing this environment in the context of three pillars: the public health impact, the economic impact and the impact on the markets. It is hard not to look at this environment without including a fourth factor: political implications. The decision to reopen is not just science driven; there will be political influence as well.
With this backdrop, within fixed income, we believe investors are showing more appetite for investment grade and high-yield corporate bonds, the latest sign of easing credit-market conditions and potential for solid performance ahead. We surveyed several Ivy portfolio managers to get their thoughts on fixed income positioning:
Given this backdrop, our Firm’s commitment to fundamentally driven, bottom-up credit research could prove to be a key advantage in navigating these choppy markets. Our portfolio managers and credit analysts review each credit to identify attractive risk-reward potential for our investors.
1. Source: Morningstar. Performance calculated when spreads reached 900 bps on the following dates: 12/1/2000, 5/1/2001, 10/1/2001, 7/1/2002, 10/1/2008, 11/1/2011.
Markit iBoxx USD Liquid High Yield Index consists of liquid USD high yield bonds, selected to provide a balanced representation of the broad USD high yield corporate bond universe. Markit iBoxx USD Liquid Investment Grade Index is designed to provide a balanced representation of the USD investment grade corporate market and to meet the investors demand for a USD denominated, highly liquid and representative investment grade corporate index.
The Bloomberg Barclays U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market and includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers. The ICE BofAML US High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. It is not possible to invest directly in an index.
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