INSIGHTS

On March 09, 2020

A Refresher Course on Why Portfolio Diversification Matters

What you see above is that credit spreads (OAS (Option Adjusted Spread)) in Investment Grade corporate bonds widened significantly last week in response to the free fall in equity prices and the trend continued the first week of March. Rapidly falling U.S. Treasury yields fell more than Credit Spreads, leaving Investment Grade (IG) yields actually lower for the week and that trend continued this week. Note that the shorter-maturity Treasuries (& corporates) fell just as much in yield as longer maturities as the Federal Reserve made an Emergency Rate Cut of 50 basis points on March 3, hoping to help offset an economic slowdown due to the impact of coronavirus. Sovereign interest rates are now falling to new all-time lows all over the world.

The more credit-sensitive High Yield bonds were near their all-time low yield on February 2, having rallied materially in February but not as much as they had given up in January as the initial concerns over coronavirus in China was enough to push down Treasury yields, but not equities. It’s interesting to note that more than half of the year-to-date move down in Treasury yields took place in January, with Investment Grade Credit Spreads widening modestly and High Yield spreads significantly. The first week in March saw credit-sensitive yields fall modestly as credit spreads widened less than the continued significant drop in U.S. Treasury rates. Credit spreads look to widen further going into the weekend on continued concerns on the virus front and further weakness in equity markets.

In the first three weeks of February stocks rose 3.5% and Treasury yields were basically flat, while Investment Grade yields ground lower on the back of slightly tighter Credit Spreads in response to higher equity prices. High Yield Credit Spreads dropped significantly, recapturing most (85%) of the January widening. In the first week of March stocks clawed back a couple of days of gains, including the greatest one-day point gain ever on the Dow (+1,294 points), but as the week came to a close it gave back all the progress. U.S. Treasury rates have fallen to new all-time lows on the longer maturities at the end of the week on the back of the 50 basis point cut by the Fed on Tuesday as well as falling rates in other countries and some pointed weakness in commodity prices, particularly energy prices.

Going forward, we believe trends should be driven primarily by two factors:

1) What further action the central banks will take to add further liquidity and how the market reacts to these efforts, and

2) Real evidence of the types and magnitude of softer sales and profits due to the impact of coronavirus. A “Dark Swan” event has arrived, the shape and speed of the recovery, by definition, will be difficult to forecast.

CRN: 2020-0302-8074 R

The opinions and views of this commentary are that of Dial Capital Management and are not necessarily that of AAM.