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While the Equity Markets Gyrate, the Corporate Bond Market Remains a Relative Sea of Calm

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While the Equity Markets Gyrate, the Corporate Bond Market Remains a Relative Sea of Calm

The price action in most financial markets so far this month has been dizzying. This may be best characterized by the CBOE’s well know (and recently well publicized) VIX index, which is a gauge for equity market volatility.
 

However, as is typical for our market, high quality bonds have behaved much calmer in recent days. And while longer-term interest have risen, which dinged prices for long bonds, most tenors and sectors within the investment grade space have produced flat returns so far this month.

One area of our universe that could see some impact from equity price volatility is corporates, as credit spreads tend to trade with some correlation to equity prices. This has been a good quarter and year for corporate profits, and it appears we’ll be in the money for a while longer. It is hard to imagine a deep sell-off when the economy is growing and corporate profits are so strong.

Corporate earnings are anticipated to be up 10.7% in 2017, and the forecast for 2018 is a 20.3% increase. Expectations are rarely this good. As the chart shows, it is hard to foresee a recession when corporate earnings are strong and growing stronger. We all know EPS growth forecasts often represent the triumph of hope over experience, yet we do have more than a few good reasons to be hopeful. A synchronized global economic expansion, continued central bank monetary accommodation, gradually higher interest rates helping banks and financials, a recovery in the energy industry lead by higher oil prices, a weaker dollar supporting overseas sales, and of course a large tax cut for corporations—all are juicing profits. We think these positive factors can hold sway for a few more quarters, so hope is alive!

Related: Will the Central Banks Drive Financial Markets in 2018?

Hope is certainly evident in the corporate bond market. While the equity markets gyrated last week, the corporate bond market was a relative sea of calm, with some (but not significant) volatility in spreads. All this makes sense to us. Great profits, continued monetary accommodation and the willingness of banks and capital markets to lend are all supportive of corporate spreads, and all dampen spread volatility.

While we are enjoying the current hopefulness, experience teaches us to keep an eye out for changes in the landscape. At SNW we are watching inflation and interest rates, which, if they increase more than expectations, can weaken many of those factors leading to strong earnings. But at the moment, we’re in the money.

Source: Bloomberg, BCA Research, the Wall Street Journal
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