Opportunities in corporate bonds

The outlook for bonds this year is an appealing one, thanks to attractive yields and expectations for subdued economic growth amid persistent inflation. 

“Bonds are in vogue; bonds are in style,” said Pablo Martinez, portfolio manager with CIBC Asset Management, in a recent interview.

“After years of financial repression where central banks kept rates very low to stimulate growth, bond yields are finally attractive.” 

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Martinez expects bond yields to remain range-bound for the rest of 2024.

“We’re not expecting yields to move up significantly higher, nor do we expect yields to move down significantly lower,” he said.

For one thing, he forecast economic slowdowns in both the U.S. and Canada, as consumers feel the effects of interest rate hikes.

U.S. consumers dug in to their savings as well as used credit to fund spending last year, Martinez noted. “This is not something that’s sustainable long term,” he said. Canadian consumers are “suffering even more” from higher rates, as they renew their mortgages. As a result, economic growth won’t be as strong this year, keeping yields from moving higher.

Martinez also doesn’t expect interest rates to move down quickly, because “inflation is sticky.” Specifically, “the wage rates in the U.S. and Canada are too high to attain that 2% target,” he said.

While central banks are expected to cut interest rates this year, the drop won’t be dramatic, he said.

The expectation for bonds yields to stay within a range is appealing: Bond investors get security and attractive yields in an environment in which risk assets are pricey, he said. 

Martinez highlighted how inflation and interest rates are currently affecting corporate bonds.

“Higher inflation is associated with increasing revenue, and increasing revenue means better ability to service debt,” he said, which is positive for corporations.

Further, when corporations issue debt in an inflationary environment, coupon payments are less in terms of real dollars, he noted. “Inflation is affecting corporate bonds positively in that sense,” too, he said. 

While higher rates would affect the bottom line of a corporation issuing new debt, many corporations issued longer-term bonds when rates were low, he said. “That is providing the flexibility that corporations need to be able to increase profits and also service debt,” he said.

For investors, higher yields and an inverted yield curve provide three opportunities, he said.

First, short-term corporate bonds trade at a higher yield, and second, these bonds offer an attractive spread to government bonds, which “enhances the all-in yield of these securities,” Martinez said.

Third, short-term corporate bonds issued two or three years ago when rates were lower are trading at a discount. “That price movement between the discount and the par price is fiscally advantageous,” he said.

In terms of sectors, Martinez recommended a cautious approach. “At this point in the cycle, we tend to prefer slightly more conservative sectors that would provide security for our investors in very uncertain times.” He cited energy, telecoms and infrastructure.

“We’re reducing sectors that will be more vulnerable to downturns in this post-Covid economy,” he said, such as retail and office real estate investment trusts (REITs).

In reference to REITs, he said, “As interest rates are staying higher for longer, those markets are showing some risk.”

This article is part of the Advisor To Go program, powered by CIBC Asset Management. It was written without input from the sponsor.