2018 Returns

The fourth-quarter selloff in equities upended the bond market total return rankings.  Prior to last quarter, corporate high yield was performing best, while long Treasuries were the poorest performers.  The high yield market had a -4.7% total return in the fourth quarter, led by a brutal -10.4% return for the CCC and weaker credits.  The BB and B credits returned -3% and -4.8%, respectively.  For the year 2018, high yield returned -2.3%.  The 2018 returns were -2.5% for BBs, -1.5% for Bs and -4.2% for CCCs.

The full Treasury market eked out a positive return of 0.80% in 2018, but the 10-year and 30-year maturities had negative returns of -0.03% and -2.71%.  Surprisingly, TIPS posted a negative return of -1.50% for the year.  Investment grade corporates returned -2.25% for the year, with the BBB credits posting the poorest returns.

The municipal market also eked out a positive return in 2018.  The 1.04% return was led by a 1.81% return from the BBB credits.  The best 2018 return by far was the 7.2% return from high yield munis, thanks to the partial recovery in prices of Puerto Rico bonds.  The second-best performing sector was asset backed securities.  This sector has a very short duration.  Short-duration strategies were clearly the most successful in 2018!!!

Looking ahead, I expect the best performing sectors in 2019 to be those that performed worst in the fourth quarter.  The selloff in high yield pushed yield on the BofAML market index from 6.25% in early October over 8% at year-end.  It is still around 8%, or approximately 525 basis points over the yield on the Treasury index.  That spread was as narrow as 320 bps in October.  A spread beyond 450 bps is, in my view, very generous for a period of good economic growth and relatively low default rates.

Speaking of economic growth, the media is now full of forecasts of slow growth in 2019 and a recession in 2020.  The first reaction to that stuff is how can we take seriously any forecasts for the year 2020?  That is too far off to allow anyone to make a useful forecast.  Of the reasonably reliable forward indicators, only stocks might be forecasting a slowdown.  But as Paul Samuelson used to say, stocks have predicted 10 of the last five recessions.  Other indicators such as initial claims, the ISM indices, consumer confidence and home sales are still predicting moderate growth.  Those are the data to watch in the months ahead.

Just when the Treasury and muni markets were beginning to offer decent value, they rallied to the point where there is now little value beyond the 5-year maturities.  The longer notes and bonds are priced as if there will be no additional increases in the fed funds rate.  That leaves those issues extremely vulnerable to any stronger-than-expected economic data or other “good news”.

Such news should, of course, be positive for the equity market and, therefore, for the high yield corporate market.  That is the basis for my view that those markets are likely to substantially outperform the Treasury market in the months ahead.

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