Investment-Grade Corporate Bonds Hold Steady as Idiosyncratic Issues Offset Broad Market Strength
For one, Kraft Heinz announced a trifecta of negative issues.
Although asset prices generally traded higher across most global markets last week, the investment-grade corporate bond market lagged behind. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade corporate bond market) was unchanged at +128. While most of the sectors underlying the investment-grade bond index tightened, that tightening was offset by idiosyncratic issues among several issuers that not only caused those companies' bonds to widen out but also drove credit spreads wider for other issuers in the same sector. For example, The Kraft Heinz Co. (BBB-, positive) announced a trifecta of negative issues: plunging profitability, asset write-downs, and a Securities and Exchange Commission investigation into its accounting.
Kraft's profitability experienced significant erosion in the fourth quarter as its adjusted operating margin fell 440 basis points. Inflation across manufacturing and transportation expenses rose faster than the company could pass though price increases. In addition, the company wrote down the value of its brand portfolio by $15 billion as consumer demand has shifted away from its iconic brands. Finally, Kraft announced that it is undergoing an SEC investigation related to its procurement accounting. Kraft's longer-dated bonds immediately widened out approximately 45 basis points in early trading before regaining some of the loss, ending the week about 30 basis points wider. Corporate bonds widened out across the entire consumer product sector as investors became concerned that the same type of margin pressure and asset write-downs could cause the credit profiles of similar companies to weaken as well.
In the auto sector, credit spreads for Ford Motor Company (BBB, negative) widened out following the company's announcement that it was investigating its fuel economy standards. Credit spreads on Ford's bonds originally widened approximately 15 basis points following the news but regained about half of the spread widening thereafter. Investors are concerned that if Ford's emissions testing has not been correctly administered, the automaker could be subject to many of the same types of costs and fines that Volkswagen was subject to following the discovery that the latter company had rigged its emissions software to pass government emissions testing but switch off thereafter.
For the week, the average spread of the consumer product sector in the Morningstar Corporate Bond Index widened out 2 basis points. The contagion spread to the retail sector, which widened out 3 basis points. The best-performing sector was the utility sector, which tightened 2 basis points. Across the rest of the markets, equities generally rose across the board as the S&P 500 rose 0.62% and most European indexes rose close to 1% for the week. Among the industrial commodities, oil prices rose above $57 per barrel and copper increased to almost $3.00 per pound. The high-yield market followed suit, with the average credit spread of the ICE BofAML High Yield Master II Index tightening 7 basis points to +405.
Technical factors remain supportive in the corporate bond market as underlying interest rates held relatively steady and investors have cash positions that they need to put to work. In the high-yield sector, although fund flows have fizzled out from their record pace at the beginning of the month, credit spreads continued to tighten. The amount of new issue supply was easily digested by the market even though the amount of new supply slightly outpaced the upper bound of Bloomberg's forecast. Further, Bloomberg reported that even though most corporate bond trading desks expected the amount of new issue volume to decline 5%-10% this year, the amount of new issuance year to date has exceeded last year by approximately 10%.
Weekly High-Yield Fund Flows Normalize After Prior Week's Surge
After posting near record highs for the amount of weekly inflows into the high-yield asset class at the beginning of February, high-yield fund flows have run out of steam. Net inflows were $0.1 billion last week, consisting almost entirely of inflows into open-end high-yield mutual funds as net unit creation among the high-yield exchange-traded funds was essentially unchanged.
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