Producer, Consumer, Import, and Export prices for April released this week.


Fixed Income Focus

Corporations continue to exhibit good financial health, which has helped drive default rates down. According to Moody’s Investment Research, defaults by corporate borrowers are below average. Last year, about 1.4% of all corporate issues globally defaulted. The average since the early 1980’s is 1.5%, and the high water mark was 5% back in 2009. The decline in defaults stands in sharp contrast to rising corporate indebtedness as outstanding non-financial corporate credit reaches a record high as a percent of GDP (chart, below).

Why Defaults Remain Low Despite Record Debt

Investors are willing to lend to companies at attractive rates, judging by low corporate bond yields relative to Treasury bonds. A positive global growth outlook, surging commodity prices, strong cash flow, tax cuts in the United States, and a wave of refinancing at attractive rates are all positives for corporate issuers. Rising short-term rates may also be encouraging some firms to issue debt to lock in low rates. Whatever the cause, the environment is a good one for corporations seeking to borrow.

The motive behind at least some of the borrowing could cause trouble for some issuers at some point. While it makes sense to borrow and invest in profitable projects, or refinance existing debt, other motives could be problematic. At this point in the cycle, companies facing intense pressure to boost otherwise weak organic growth may turn to buybacks and acquisitions. Strong levels of these activities, which can convey benefits in some environments, could prove damaging if done for the wrong reasons.

By leveraging a balance sheet to achieve near-term growth targets, a business increases risk and decreases flexibility, especially if interest costs rise or business conditions worsen in the future. While not a problem at this point, we have seen many times before how debt growth can lead to trouble for the economy.

How We Are Allocating Credit Exposure Now

If the economy suffers a downturn, we would expect default rates on lower quality, non-investment grade issues to experience default rates 2-3 times higher than investment grade. Increasing the exposure to higher-quality investment grade and Treasury bonds is one way to lessen credit risk should the economy suffer a downturn. While we don’t predict such an outcome at present, we reduced to neutral exposure to high yield corporate bonds during last summer. We also raised to neutral from underweight U.S. Treasury exposure.

The increase in indebtedness of U.S. non-financial companies is manageable in the current environment. Steady growth, strong cash flow, and investor confidence supports today’s low default rates. Still, it is important to keep an eye on how these trends evolve and recognize potential for increased risk, especially among weaker credits, should conditions change.


Date Report Period Survey Prior
Mon, May 7: No Economic Data
Tues, May 8: JOLTS Mar 6.052M
Wed, May 9: PPI M/M Apr 0.3%
PPI Y/Y Apr 3.0%
PPI ex Food & Energy M/M Apr 0.3%
PPI ex Food & Energy Y/Y Apr 2.7%
PPI ex Food, Energy & Trade M/M Apr 0.4%
PPI ex Food, Energy & Trade Y/Y Apr 2.9%
Thurs, May 10: Weekly Jobless Claims May 5 211K
CPI M/M Apr -0.1%
CPI Y/Y Apr 2.4%
CPI ex Food & Energy M/M Apr 0.2%
CPI ex Food & Energy Y/Y Apr 2.1%
Treasury Budget Apr -$208.7B
Fri, May 11: Consumer Sentiment May 98.8
Import Prices M/M Apr 0.0%
Export Prices M/M Apr 0.3%
Import Prices Y/Y Apr 3.6%
Export Prices Y/Y Apr 3.4%
Source: Bloomberg


Based on shorter-term expectations, the “tactical satellite” allocation within portfolios is:

Overweight Stocks vs. Bonds

Kevin Caron, CFA, Senior Portfolio Manager
Chad Morganlander, Senior Portfolio Manager
Matthew Battipaglia, Portfolio Manager
Suzanne Ashley, Analyst

(973) 549-4168





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