High-Yield Bonds Continue to Outperform Investment Grade

The ongoing investor preference for higher-beta assets that has driven the market since oil prices bottomed in February 2016 has continued thus far in 2017. Since the beginning of the year, the average corporate credit spread of the Morningstar Corporate Bond Index, our proxy for the investment-grade bond market, has tightened 1 basis point, whereas in the high-yield market, the credit spread of the Bank of America Merrill Lynch High Yield Master Index has tightened 19 basis points. Between tightening credit spreads and a slight rebound in Treasury bonds, fixed-income securities have performed well. Year to date, the Morningstar Corporate Bond Index has risen 0.53% and the high-yield index has risen 1.08%. However, risk assets with higher betas have risen even higher; for example, the S&P 500 has risen 1.6% over the same period. The impetus for the movement has been the market’s expectation that the economy is entering a reflationary environment based on renewed economic activity, which will be spurred by fiscal stimulus and tax reductions. In addition, oil prices and industrial commodities have not only stabilized but are trending upward.

At these levels, both investment-grade and high-yield corporate bonds are trading much tighter than their long-term averages, and the S&P 500 is only slightly below its all-time high. Currently, the average spread of the Morningstar Corporate Bond Index is +127, which is 41 basis points tighter than its long-term average of +168 since the end of 1998. The average spread of the Bank of America Merrill Lynch High Yield Master Index is currently +402, which is 178 basis points tighter than its long-term average of +580 basis points since the end of 1996. As a point of reference, the tightest that the Morningstar Corporate Bond Index has ever traded was +80 in February 2007, and the tightest the high-yield index registered was +241 in June 2007.

The tone of corporate bond market ended the week on a positive note as earnings season swung into gear, starting with the major global banks. Fourth-quarter results were favorable, as earnings were bolstered by modestly higher net interest income, significant reductions in operating costs, and lower credit losses. Among the banks we rate, JPMorgan Chase (JPM) (rating: A-, stable) reported solid fourth-quarter results, including net income available to common shareholders of $6.2 billion, which was 26.1% higher than a year ago and 7.7% higher sequentially. Compared with the relatively weak year-earlier quarter, results were supported by modestly higher net interest income revenue. However, the bottom line benefited more from lower expenses across the board. Operating costs decreased 3.0% year over year, while credit costs decreased an impressive 30.9%. Relative to the more robust results reported in the third quarter, total revenue decreased 5.2%, but fourth-quarter results were aided by lower operating, credit, and tax expenses. Bank of America (BAC) (rating: BBB, stable) reported generally solid fourth-quarter results that were considerably higher than relatively weak results reported a year ago but modestly below those reported in the prior quarter. While our credit assessment is strengthened modestly by a third consecutive quarter of respectable results, Bank of America’s profitability remains at modest levels and continues to trail key peers.

Morningstar Credit Ratings, LLC is a credit rating agency registered with the Securities and Exchange Commission as a nationally recognized statistical rating organization (“NRSRO”). Under its NRSRO registration, Morningstar Credit Ratings issues credit ratings on financial institutions (e.g., banks), corporate issuers, and asset-backed securities. While Morningstar Credit Ratings issues credit ratings on insurance companies, those ratings are not issued under its NRSRO registration. All Morningstar credit ratings and related analysis contained herein are solely statements of opinion and not statements of fact or recommendations to purchase, hold, or sell any securities or make any other investment decisions. Morningstar credit ratings and related analysis should not be considered without an understanding and review of our methodologies, disclaimers, disclosures, and other important information found at https://ratingagency.morningstar.com