Views on my blog posts have picked up recently, so I checked to see which topics seem to be the most popular. To my surprise, my recent posts on bond credit spreads have gotten the most “hits”! So, in honor of that result, here is an update on how credit spreads have trended recently and how that impacts my views on long term strategic investing.
Per the chart below, it is clear to see that credit spreads (red and blue lines) have normalized to flat-line over the past few months in the face of generally rising rates (green line). This is in no doubt due to significant pricing support from the Fed through bond ETF purchases and other actions. Through April 30, 2021 the Fed holds $8.6 billion of bond ETFs in the investment grade and high yield sectors (source: federalreserve.gov) including $2.3 billion of iShares IBOXX Inv Grade Credit (LQD) and about $1 billion in iShares IBOXX High Yield (HYG) and SPDR High Yield (JNK).
As of today, 10-year Treasuries yield a modest 1.64% with corporate investment grade credits yielding 2.56% (+0.92% spread) and high yield corporates yielding 5.04% (+3.40% spread). Unlike late last year with 10-year rates in the 0.70% range, these higher yield levels offer a better entry point into bonds and provide a better, but not necessarily meaningful, alternative to equities.
The best way to handle this market dynamic is to opportunistically rebalance outsized equity market gains back into bonds consistent with long term strategic asset allocation targets that are meant to help an investor achieve their goals. In this way, you will be selling equities “high” and buying bonds “low” after the recent rise in rates. Of course, if rates trend higher from here, there is the potential for bond values to erode further, but there is also the added benefit from the higher “carry” from the higher yield to offset that erosion plus preserving the equity market gains with lower risk fixed income holdings.