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Bonds and loans issued by riskier U.S. companies with speculative, or “junk,” credit ratings likely offer investors better downside protection than stocks as investors gauge recession risks, according to asset manager Nuveen.
With investors focused on the Federal Reserve’s potential to slam the brakes on the U.S. economy as it moves to dramatically raises rates to help cool stubbornly high inflation, corporate bonds and loans offering far meatier yields than in recent years likely provide investors better downside protection, Saira Malik, Nuveen’s chief investment officer, wrote in a Monday client note.
The yield on the ICE BofA U.S. High Yield Index has more than doubled to about 8.4% from a record low of less than 4% about a year ago, even though “credit fundamentals appear strong,” according to Malik. The index tracks companies with below investment-grade credit ratings, or in the BB to D category.
While excessive borrowing can come back to bite, the record boom in pandemic debt issuance at ultralow yields has been a positive factor for many companies with weaker credit profiles, she said, given that “debt burdens aren’t excessive and low financing rates have been locked in.”
Specifically, Nuveen pegged about 75% of outstanding junk bonds and loans as coming due after 2025 (see chart), giving speculative-grade companies more wiggle room if a recession hits, a threat more investors, Wall Street analysts and corporate executives increasingly view as likely.
75% of junk-rated corporate debt matures after 2025
Nuveen, Bloomberg
Companies often end up defaulting when profits sag in a downturn, debt payments climb too high or they fail to repay or refinance debt coming due.
To that end, Nuveen notes that U.S. high-yield companies have been generating profits that cover roughly four times their annual interest expenses, the highest level since 2008, and that default rates are unlikely to rise to current market expectations of about 5%.
Nuveen, a division of TIAA, has roughly $1.2 trillion in assets under management, with a large focus on fixed income, stocks and real estate.
The team conducted a hypothetical stress test based on a 20% decline in equities and current bond and stock dividend yields, finding that stock prices could fall 19.5%, but that high-yield bonds shed only 4.5% and loans lost 4%.
The S&P 500 index
SPX,
was down 19.7% on the year through Monday, while the Dow Jones Industrial Average
DJIA,
was off about 14.6% and the Nasdaq Composite Index
COMP,
was lower by 27.5% for the same stretch, according to FactSet.
For bonds, total returns for the year through July 8 were negative 12.9% for U.S. high-yield, minus 14.3% for investment-grade and negative 4.6% for leveraged loans, according to Mizuho Securities.
Individual investors often gain exposure to high-yield bonds through exchange-traded funds, including the large SPDR Bloomberg High Yield Bond ETF
JNK,
and iShares iBoxx $ High Yield Corporate Bond ETF
HYG,
which were down about 15% and 13.8%, respectively, so far in 2022, according to FactSet.
While over the long term, Nuveen expects stocks to “provide higher upside,” equities appear more vulnerable to “near-term risks, particularly amid the uncertainty of the current earnings season.”
