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30 April 2021 | GSAM Connect

Credit Check-In: The Intersection of Technicals and Fundamentals

In short: We think US investment grade corporate credit will provide decent carry-driven returns in 2021, with high supply being met by high demand, while the economic rebound supports balance sheet fundamentals. That said, we are closely monitoring signs of equity-friendly activities, profit margin headwinds from higher input prices, and tax policy changes.

1. Technically Fine. New bond issuance remains robust following a record-setting 2020. US investment grade supply amounted to $599bn in the first quarter; the second strongest start to the year on record1. So far, the impact on spreads from high supply (and the reflation-driven rate sell-off earlier this year) has been limited, and new issue concessions2 have remained modest. One reason for this resilience is high investor demand, particularly from liability-driven investor (LDI) strategies3 and foreign investors as discussed below:

  • Pension Demand. We estimate the funded status for the aggregate S&P 500 was 96.2% as of March 2021, up from 89.4% and 87.2% in 2020 and 2019, respectively4. The typical pension glide path suggests that this improvement will be associated with an increased allocation to fixed income. Since the liabilities of corporate pension plans are based on the yield of high-quality corporate bonds, the US investment grade market is well-positioned to benefit from LDI demand as plans move closer to funded status.
  • Foreign Demand. Attractive carry—particularly for intermediate and long-dated US corporate bonds relative to other markets—coupled with low sovereign bond yields, will likely stimulate ongoing demand from foreign investors.

2. Fundamental Improvements. We think the economic recovery will benefit corporate earnings and cash flows, particularly for companies that were most exposed to virus-related disruptions. We are mindful, however, that some companies managed to maintain—if not improve—balance sheet positions during 2020. For this cohort, we would not be surprised to see capital allocation normalize in 2021 through debt-funded M&A or share repurchases. By contrast, we think companies in virus-sensitive industries will largely uphold balance sheet discipline and look to repair credit metrics. Finally, we are also mindful of tax policy changes and profit margin headwinds that may arise from higher input costs (stemming from supply-chain disruptions, raw materials inflation, wage growth and higher freight costs). At a macro-level, we think underlying inflation pressures will remain subdued.5 At a company-level, we think profit margin pressures may differ by business model, underscoring the importance of security selection.

 

Overheard at Goldman Sachs

Each month we feature quotes from our investment team, offering a glimpse into what we are monitoring and analyzing.

“UK Department of Transport “road usage” high frequency statistics, re-confirm the re-opening of the UK economy continues apace, aided by the success of the vaccination policy."

— Corporate Credit Research Analyst | April 21, 2021

 

1. Source: Goldman Sachs Global Investment Research, Bloomberg Barclays. As of April 27, 2021.
2. The spread discount or premium at which new issue bonds are priced vs. the secondary market.
3. LDI strategies seek to match long-term pension liabilities with cash flows from long-dated investments and tend to be a key driver of net demand for long-duration US investment grade corporate bonds.
4. See Corporate Pension Quarterly Q1 2021: Opportunity Knocks. Estimate is based on U.S. plans (where specified) of pension plans within the S&P 500. The economic and market forecasts presented herein have been generated by GSAM for informational purposes as of the date of this presentation. They are based on proprietary models and there can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this presentation. Past performance does not guarantee future results, which may vary.
5. See Inflation – It's a Jungle Out There (March 2021).

Stay posted on the latest market developments and key investment implications.

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