Despite the Fed's More Dovish Tone, Expectations Remain the Same
Retailers' bonds outperform while energy bonds continue to underperform.
While Wednesday's Federal Open Market Committee statement was decidedly more dovish, as the phrase "considerable time" remained and the word "patient" was inserted into the discussion regarding the timing for a possible rate hike, the truth is that not much has changed. "Patient," as defined by Fed Chair Janet Yellen, means no anticipated rate hike until sometime after the March 17-18 meeting, which is what the market had already been anticipating. Still, the equity market was sent soaring, as the S&P 500 ended the week up 5.0% from Tuesday's close, recovering losses from its minicorrection the prior week. Concerns about falling oil prices and the collapse of the rouble were placed on the back burner and the market continued on its path to around a 12% return for 2014. The bond market also took a roller-coaster ride last week with high yield temporarily moving into negative return territory for the year before rebounding to a slightly positive position of 1.6%. The Merrill Lynch High Yield Master II Index actually rallied 38 basis points for the week, beginning its rocky path at +547 before ending at +509. Year to date, though, the picture remains pretty clear that investors have been moving up in credit quality as the high-yield index has widened more than 100 basis points in 2014. While skewed by recent energy sector performance, the index excluding energy still shows a full-year spread widening of 52 basis points. By contrast, the investment-grade bond market, measured by the Morningstar Corporate Bond Index, ended the week flat at +141 basis points, despite having widened to +149 last Tuesday, and is 21 basis points wider since the start of the year. The flight-to-safety strategy was rewarded this year, but we think the high-yield market may be oversold. While the fallout from low oil prices will take time for the energy sector to sort out, we don't think the investors' paintbrush should be too wide. With signs of a strengthening economy and particularly a stronger consumer who was handed a big break through lower oil prices, we think good high-yield opportunities will be selectively available in 2015.
Retailers' Bonds Outperform While Energy Bonds Continue to Underperform
Energy credits continue to weigh on our overall index because of the impact of dramatically lower oil prices (West Texas Intermediate is currently at $56 a barrel from a peak of more than $107 near the end of June). Retailers have been the beneficiary of lower oil prices as the declining prices at the pump boost consumer spending. Retail sales growth in November was stronger than expected at 0.7%, and we expect continued growth through the holiday season. However, we think this is already priced into retailers' bonds, and we are market weight on the preponderance of our retail names. After underperforming throughout the first half of 2014, year to date the retail segment of the Morningstar Corporate Bond Industrials Index has outperformed the overall index, widening just 18 basis points compared with 28 basis points for the overall industrials index. Much of the outperformance has been since June, when oil prices began to decline. Retail spreads have widened only 26 basis points since June 30, while the industrials index has widened 43 basis points, an outperformance of 18 basis points.