skip navigation

Stay up to date on timely topics and market events. Subscribe to our Blog now.

12 August 2021

Corporate Bonds Are Still Okay, Even at Tighter Valuations

By James J. So

Stay up to date on timely topics and market events. Subscribe to our Blog now.

About a year ago one vein of concern we pushed back against was alarm over the massive amount of bonds corporate America was issuing. US investment-grade credit did hit a new record in 2020, exceeding $2 trillion of gross new supply, whereas that figure averaged approximately $1.3 trillion in the preceding five years. What gave us comfort in being healthily overweight IG credit in our strategies then was: (A) the origin of the recession—it was a reduction of economic activity by government edict rather than due to massive imbalances in corporate fundamentals; (B) the defensive nature in how corporate management was responding to the crisis—cash raised was held and not distributed to equity holders, and (C) attractive valuations. Roll the calendar forward to today and overall index spreads have not only fully recovered but have touched levels not seen since early 2007, before the financial crisis. While valuations are no longer obviously cheap, we believe the risk/reward framework is still supportive due to favorable fundamentals, technicals and valuations.


With almost 90% of the S&P having reported Q2 earnings and more than 80% of those beating expectations, on both the top and bottom line, corporate fundamentals are solid. Leverage metrics are starting to turn south due to both passive (earnings growth) and active (debt tenders) deleveraging efforts. Headwinds are emanating from supply chain disruptions and input cost increases; however, against that backdrop management has wrung savings through productivity enhancements (as witnessed by GDP fully recovering while the labor market is still shy of pre-Covid levels). The banking system, which is the lubricant of credit transmission needed for economic growth, not only survived Covid but has thrived and is in better shape than ever. We are always on the lookout for re-leveraging activity (e.g., LBOs), but the pieces are in place for corporate fundamentals to remain strong and/or improve should the reopening theme gain further momentum.


The supply/demand backdrop also remains supportive. Supply is on track to exceed the pre-Covid years but is down drastically from last year’s pace, while demand continues to be robust. Globally, the hunt for yield continues with about $16 trillion of negative-yielding debt outstanding. We’re still in the summer months and cumulative YTD fund flows into IG bond funds are already nearing full 2019 and 2020 levels. Add to that the demand from private pensions legging further into LDI as their funded statuses have improved. Also fast approaching is likely demand from multi-employer pensions; within the American Rescue Plan (the $1.9 trillion Covid relief package passed in early 2021) was a bailout of severely underfunded multi-employer plans. The Pension Benefit Guaranty Corporation (PBGC) estimates that the US Treasury will distribute approximately $94 billion to plans in need with the stipulation that these Special Financial Assistance (SFA) assets must be invested in IG bonds.


While only just fair from a historical comparison perspective we don’t see any potential catalyst on the horizon that could take overall spreads meaningfully wider. As mentioned earlier we are watching for signs of late-cycle behavior, such as LBOs (there have been a good deal of assets allocated to private equity), but the risk tone in the credit markets these days is swayed by macro issues such as whether Covid variants may derail the reopening momentum. And just like the population, firms have also built up some immunity (from a business operating model perspective), while policymakers now have an expanded emergency playbook of tools tested last year.

Looking Ahead

We believe the spread compression trade is largely behind us—but even if spreads trend sideways, credit should outperform the other major sectors of the IG bond market, namely governments and fixed-rate mortgages. Within credit we still see opportunities in banks (ratings upgrades should be coming shortly), energy (trades wide of almost all other industrial subsectors even as underlying oil prices are now higher than where they were pre-Covid) and the reopening sectors.

© Western Asset Management Company, LLC 2024. The information contained in these materials ("the materials") is intended for the exclusive use of the designated recipient ("the recipient"). This information is proprietary and confidential and may contain commercially sensitive information, and may not be copied, reproduced or republished, in whole or in part, without the prior written consent of Western Asset Management Company ("Western Asset").
Past performance does not predict future returns. These materials should not be deemed to be a prediction or projection of future performance. These materials are intended for investment professionals including professional clients, eligible counterparties, and qualified investors only.
These materials have been produced for illustrative and informational purposes only. These materials contain Western Asset's opinions and beliefs as of the date designated on the materials; these views are subject to change and may not reflect real-time market developments and investment views.
Third party data may be used throughout the materials, and this data is believed to be accurate to the best of Western Asset's knowledge at the time of publication, but cannot be guaranteed. These materials may also contain strategy or product awards or rankings from independent third parties or industry publications which are based on unbiased quantitative and/or qualitative information determined independently by each third party or publication. In some cases, Western Asset may subscribe to these third party's standard industry services or publications. These standard subscriptions and services are available to all asset managers and do not influence rankings or awards in any way.
Investment strategies or products discussed herein may involve a high degree of risk, including the loss of some or all capital. Investments in any products or strategies described in these materials may be volatile, and investors should have the financial ability and willingness to accept such risks.
Unless otherwise noted, investment performance contained in these materials is reflective of a strategy composite. All other strategy data and information included in these materials reflects a representative portfolio which is an account in the composite that Western Asset believes most closely reflects the current portfolio management style of the strategy. Performance is not a consideration in the selection of the representative portfolio. The characteristics of the representative portfolio shown may differ from other accounts in the composite. Information regarding the representative portfolio and the other accounts in the composite are available upon request. Statements in these materials should not be considered investment advice. References, either general or specific, to securities and/or issuers in the materials are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendation to purchase or sell such securities. Employees and/or clients of Western Asset may have a position in the securities or issuers mentioned.
These materials are not intended to provide, and should not be relied on for, accounting, legal, tax, investment or other advice. The recipient should consult its own counsel, accountant, investment, tax, and any other advisers for this advice, including economic risks and merits, related to making an investment with Western Asset. The recipient is responsible for observing the applicable laws and regulations of their country of residence.
Founded in 1971, Western Asset Management Company is a global fixed-income investment manager with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Zürich. Western Asset is a wholly owned subsidiary of Franklin Resources, Inc. but operates autonomously. Western Asset is comprised of six legal entities across the globe, each with distinct regional registrations: Western Asset Management Company, LLC, a registered Investment Adviser with the Securities and Exchange Commission; Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorized and regulated by Comissão de Valores Mobiliários and Brazilian Central Bank; Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services License 303160; Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services License for fund management and regulated by the Monetary Authority of Singapore; Western Asset Management Company Ltd, a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan; and Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority ("FCA") (FRN 145930). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK as defined by the FCA. This communication may also be intended for certain EEA countries where Western Asset has been granted permission to do so. For the current list of the approved EEA countries please contact Western Asset at +44 (0)20 7422 3000.