Choose auto sector bonds

Fixed-income investors should look to the high-yield market.

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That’s because yield-to-maturity for this market is around 5.8%, a spread of about 480 basis points, says Nicholas Leach, vice president of global fixed income at CIBC Asset Management. He manages the Renaissance High-Yield Bond Fund.

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In contrast, U.S. investment-grade corporates have a yield of around 2.8%, a spread of about 151 basis points. The yield for Canadian corporates is about 2.8%, or a 122-point spread.

“Relative to investment-grade Canadian and U.S. corporations, there’s still a lot of value in the high-yield market,” says Leach. He adds opportunities range across several sectors, and he favours the North American automobile industry.

Read: Corporate bonds mitigate U.S. growth risks

“We’ve been overweight the auto sector for a long time, and have a positive outlook for North American vehicle sales—they’ve been improving for the last three years,” he says.

But from a historical perspective, they’re still relatively weak.

“Currently, the domestic annual selling rate is around 12 million vehicles,” says Leach.

He adds, “While this is the highest since the recession, it’s still much lower than what we saw in the 1970s and 1980s. Over those 40 years there’s been population growth, so there are a lot more drivers on the road, but we’re still at an annual selling rate we saw decades ago.”

The Federal Reserve has been very accommodative in its effort to get U.S. unemployment down. This may change, however, now that the number of unemployment claims filed in the U.S. recently fell to a five-year low.

That said, the country’s GDP growth still lags and consumer confidence is weak. It’s 30%-to-40% below where it was before the recession.

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Leach says, “Against a pretty weak economic backdrop, Chrysler and the other auto companies are generating good sales growth. [They’re] improving their margins and generating excellent free cash flow. But there isn’t as much automotive production capacity as there was prior to the recession.”

Overall, he says credit quality for high-yield products is still positive, with default volumes sitting at less than 2%.

“Companies are generating free cash flows and growing revenues. This is in the context of a high unemployment rates and weak consumer confidence,” adds Leach. But even though economies still have some recovery work to do on a macro-level, high-yield companies have good balance sheets and are strong operationally.

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