Capital Ideas^TM

Global investment-grade corporates staged a strong rally in the fourth quarter of 2022, ending three quarters of negative returns. Risk aversion peaked in October before sentiment turned amid growing expectations of a Fed pivot following better-than-expected US inflation data. Global investment-grade spreads reached 187 basis points (bps) during the quarter, but had tightened to 147 bps by year-end, resulting in a total return on the Bloomberg Global Aggregate Corporate Index of 5.4% (in USD) for the quarter. From a sector perspective, utilities outpaced industrials and financials. GBP- and EUR-denominated bonds did particularly well, helped by currency appreciation.

Growing market dispersion

As at 31/12/2022. Chart shows the proportion of investment-grade and BBB-rated bonds trading +/-25bps outside of that rating's sub-index level. Index: ICE BofA IG Index. Source: BofA Global Research

The outlook for the sector is balanced. Spreads are now trading at levels that do not reflect the likely recessions in the US and Europe in 2023. If inflation proves to be stickier than expected and central banks continue to prioritise price stability over financial stability, markets could be disappointed and would need to reprice a deeper recession and/or higher terminal rates for this hiking cycle. Currently, consensus expectation is for the Fed to start cutting rates in the second half of 2023.

After the repricing in 2022, global investment-grade corporates look attractive from a yield perspective, with the Bloomberg Global Aggregate Corporate Index yielding 5.2% in USD terms as at end-2022. Moreover, providing correlations between core fixed income and risk assets return to normal as we expect, the asset class’s relatively long duration means it could also provide diversification from equities and capital preservation if risk sentiment deteriorates.

Growing proportion of bonds in high spread buckets

As at 31/12/2022. X axis shows the different spread buckets. Index: Bloomberg Global Aggregate Corporate Index. Source: Bloomberg

We are neutral overall on credit risk but hold a higher than usual cash position for idiosyncratic opportunities in sectors and regions given the increased dispersion in the market (see charts). As at 31 December 2022, we are overweight on sectors such as autos and chemicals and underweight communications and consumer non-cyclicals, such as food/beverage, health care and pharma, and energy. We have also continued to increase exposure to Euro-denominated bonds due to more attractive valuations.