High Grade Spreads Are Now at Recession Levels

Investment grade spreads to U.S. Treasuries are now pricing in recession. As a matter of fact, the spreads are now higher than 4 out of the past 5 recessions.

Why?

Because people are boarding the ark, afraid of the dangers that lie ahead.

This is a very classic trade, one that is taught in every business school around the world. If you believe an economic contraction is around the bend, buy treasuries.

“There is a lot of value out there,” said Stephen Antczak, head of credit strategy at Citigroup. The reaction in corporate bonds “has been so drastic and so violent — above and beyond what the fundamentals and even the extreme volatility should dictate,” said Antczak, who in 2007 as a high-yield strategist at UBS AG recommended reducing holdings of risky corporate debt.

U.S. corporate bonds have lost 0.312 percent so far this year, the worst start to a year in 16. Borrowing costs for investment-grade companies have soared to a four-year high as Standard & Poor’s warned that the outlook for corporate borrowers worldwide was the worst since 2009.

Recession Worries

The risk premium on the Markit CDX North American Investment Grade Yield Index, a credit-default swaps benchmark tied to the debt of 100 of the safest companies, surged to 112.47 basis points, the most in more than three years. A similar measure for junk debt is at the highest mark since 2012.

There’s still plenty of concern that these signs are pointing to an increased chance of recession, according to Bonnie Baha, who helps oversee $80 billion at DoubleLine Capital. “We have seen a ton of borrowing that doesn’t generate revenue,” said Baha. “At some point that becomes very deflationary. And then you have to worry more about the preservation of your capital than finding value.”

Baha said that DoubleLine has reduced its holdings of investment-grade bonds in recent months.

Buy Credit

At Vanguard Group Inc., Gregory Nassour, principal and co-head of investment-grade portfolio management, is starting to buy some of those bonds. “Credit is weaker than it has been, but not everything is all bad. There are still things to buy,” Nassour said. “You are seeing a lot of volatility, you will see a lot more ebb and flow, but it’s not the end of the world.”

While commodities-related issuers have suffered the most, fears of a meltdown has also spread to other sectors. And that’s where some of the best buys are for Mark Kiesel, the chief investment officer for global credit at Pimco.

Kiesel said he favors sectors like consumer goods, housing, health care, pharmaceuticals and building materials, which have been beaten down along with commodities-related issuers and emerging markets as investors fret about a slowdown in global growth. Consumer-sector debt is down 0.5 percent in the past two weeks, with brewer Anheuser-Busch InBev NV, PepsiCo Inc. and Kraft Heinz Co. among the worst performers in the sector.

‘Bottom Line’

“The bottom line is that the U.S. consumer is almost 70 percent of the U.S. economy and we don’t see a U.S. recession this year,” Kiesel said in an e-mail. “Yet the credit markets are increasingly ‘pricing in’ a higher chance of recession, which is where the opportunity is. We want to stay ‘high quality’ and favor U.S. consumer-oriented sectors.”

“You still have to brush your teeth, wash your hair, eat and drink, and companies in those sectors have weakened along with everything else,” said Jim Caron, a managing director at Morgan Stanley Investment Management, which oversees $406 billion. “The market is pricing in a recession that when you look at fundamentals looks increasingly unlikely, and there is a whole grocery store of things that look cheaper than they ought to be.”

If take a step back and think about the scale and magnitude of the Janet Yellen Fed fuck up, it’s astounding. She has single handedly caused hundreds of billions in losses, forced investment grade spreads to blow out v treasuries and haas done nothing to remedy the situation, after having the benefit of seeing her disastrous results.

It will be interesting to see what the Fed says tomorrow.