Download the Schwab app from iTunes®Get the AppClose

Are There Cracks in the Corporate Bond Market?

What a difference a decade makes.

Following the 2008–2009 financial crisis, U.S. Treasuries yielded next to nothing, as investors fled to the relative safety of government-issued debt and the Federal Reserve slashed its benchmark interest rate to help stimulate the economy. Meanwhile, low borrowing costs and a growing U.S. economy helped riskier U.S. corporate bonds outperform their federal counterparts.

Today, U.S. Treasuries offer relatively attractive yields, while investment-grade U.S. corporate bonds last year suffered their worst annual performance in a decade.1

What happened? And could the U.S. corporate bond market continue its recent slide?

More of the same

We believe U.S. corporate bond yields are poised to move modestly higher throughout 2019 and into 2020—which could continue to pull prices lower and negatively impact total returns from U.S. corporate bond funds. (Remember, bond prices fall when yields rise.) Four key factors are to blame:

  • A surge in U.S. corporate debt: Over the past decade, the amount of debt issued by nonfinancial U.S. companies ballooned 48%, to nearly $9.8 trillion—which is raising fears of a potential bubble (see “Precarious heights,” below).
  • Rising interest rates: Repeated interest rate hikes have caused Treasury yields to rise, giving income-seeking investors a viable alternative to riskier U.S. corporate bonds, even as they’ve made it more expensive for corporations to borrow. Higher borrowing costs can eat into not only a company’s profitability but also its ability to service outstanding debt, increasing the risk of default.
  • The rise of triple Bs: More than half the market now consists of U.S. corporate bonds rated the lowest in the investment-grade category (BBB+ through BBB- by Standard and Poor’s and Baa1 through Baa3 by Moody’s Investors Service). That could be a problem for risk-averse investors who rely on funds or strategies that passively track an index.
  • The risk of downgrades: The investor base for high-yield U.S. corporate debt is limited, and if the glut of triple Bs previously mentioned is downgraded, the price of high-yield U.S. corporate bonds may need to move sharply lower in order to sufficiently entice prospective buyers.

 

Precarious heights

Total nonfinancial U.S. corporate debt surged 48% from year-end 2008 through year-end 2018, raising concerns of a bubble.

Source: Bloomberg, as of fourth quarter 2018. Nonfinancial U.S. corporate debt is represented by FOF Nonfarm Nonfinancial Corp Business; Credit Market Instruments; Liability Index. Total debt includes both bonds and loans from private and public issuers.

 

What can you do?

As a result of these risks, we suggest investors take a more cautious stance toward U.S. corporate bonds in 2019. Investors needn’t abandon their U.S. corporate fixed income holdings, but they should consider moving up in quality.

Investors in triple-B-rated U.S. corporate bonds, for example, might consider reducing their exposure in favor of those with ratings of A or above. Although triple-B-rated corporate bonds were yielding 4.3% in mid-February, those rated A were yielding 3.6%—among their highest levels since 2011.2

Bond-fund investors, in particular, should bear in mind that many index-tracking investments have a lot of exposure to BBB-rated securities. If that’s outside your comfort zone, you may want to consider strategies that take a more active approach and focus on higher-rated parts of the market.

Finally, if you’re a high-yield U.S. corporate bond investor, make sure you’re comfortable with the risks. High-yield bonds can suffer large price declines in short periods of time. In the fourth quarter of 2018, for instance, the average price of the Bloomberg Barclays U.S. Corporate High Yield Bond Index dropped by more than 6%. If that kind of price decline is too steep for your tastes, consider moving up to higher-rated, intermediate-term bonds.

1Bloomberg Barclays U.S. Corporate Bond Index.

2Bloomberg Barclays Indexes, as of 02/19/2019. Comparison is based on the yield-to-worst of the Bloomberg Barclays U.S. Corporate A Rated Bond Index and the Bloomberg Barclays U.S. Corporate Baa Rated Bond Index.

What You Can Do Next

  • Subscribe to Schwab Market Reports to stay up to date on happenings in the fixed-income market.
  • Need helping reassessing your bond investments? Call 800-355-2162 to speak with a Schwab fixed income specialist.
Creating a Financial Plan in 3 Steps
Four Reasons to Invest in REITs

Important Disclosures:

Past performance is no guarantee of future results.

Fixed-income securities are subject to increased loss of principal during periods of rising interest rates. Fixed‐income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The Bloomberg Barclays U.S. Corporate Bond Index covers the U.S. dollar-denominated investment-grade, fixed-rate, taxable corporate bond market. Securities are included if rated investment-grade (Baa3/BBB-/BBB-) or higher using the middle rating of Moody’s, S&P and Fitch ratings services. This index is part of the Bloomberg Barclays U.S. Aggregate Bond Index (Agg).

The Bloomberg Barclays U.S. Corporate High-Yield Bond Index covers the U.S. dollar-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

The Bloomberg Barclays U.S. Corporate Bond Index covers the U.S. dollar (USD)-denominated investment-grade, fixed-rate, taxable corporate bond market. Securities are included if rated investment-grade (Baa3/BBB-/BBB-) or higher using the middle rating of Moody’s, S&P and Fitch ratings services. This index is part of the Bloomberg Barclays U.S. Aggregate Bond Index (Agg). The Bloomberg Barclays U.S. Corporate A Rated Bond Index and the Bloomberg Barclays U.S. Corporate Baa Rated Bond Index are sub-indexes of the broad corporate bond index, broken down by credit rating.

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

(0519-9EAF)

Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.