In the year ending May 31, corporate bonds returned 2.6%, compared to -4.4% for Government of Canada bonds and -3.5% for provincial bonds,” said Patrick O’Toole, Vice President, Global Fixed Income, CIBC Asset Management.
Although this outperformance will not be as significant in the coming year, strong economic growth and low default risk should once again propel corporates to higher yields than sovereigns.
Many companies have taken advantage of low interest rates to refinance their debt, O’Toole said, extending their average term to maturity and reducing the risk of default. Government aid has bloated balance sheets, and credit market debt to equity of non-financial corporations in the United States is at record highs, he said.
“The backdrop remains good for Canadian businesses and U.S. businesses, which means demand should remain strong for corporate bonds, which means the average credit spread may narrow somewhat,” O said. ‘Toole. “And the result is better corporate bond returns relative to government bonds over the next year.”
While there’s more risk for investors looking beyond higher-quality companies, O’Toole sees “a green light for the high-yield sector as well” in the coming year.
“That doesn’t mean you can be complacent about high yield, so you need to be very well diversified and know the business,” he said. “And we will look at the maturity wall for high-yield businesses, avoiding businesses where refinancing might be a risk or where industry risks are increasing.”
He said he is overweight the core industrials sector with high-yield names, for example, but underweight US REITs given the uncertainty over office space and retail. retail.
The energy sector presents another potential risk. A strong economic rebound is supporting oil prices, and energy companies have been better performers in the high-yield bond sector, but the outlook can change quickly if the price of oil drops, O’Toole said.
There’s also the possibility of policy error as the US Federal Reserve scales back bond purchases, like during the 2013 crisis, he said.
But the biggest risk is inflation, O’Toole said. If the higher reading over the past few months is not temporary, bond yields and credit spreads could rise and stocks could fall.
“If the inflation genie comes out of the bottle, we’re not talking about something like the 1970s, where you necessarily have double-digit inflation, but it might be hard to put it back in the bottle,” said O’Toole.
But he said he expects inflation to return to 2% in a year, proving the Fed right.
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