Corporate Bond Outlook for 2022

Featuring

Patrick O’Toole

From

Related Article

Text transcript

Patrick O’Toole, vice president Global Fixed Income, CIBC Asset Management.

We continue to see that corporate bonds are flashing a healthy signal for investors. We have several indicators that we use to gauge the health of the backdrop for the corporate bond market. To simplify, the economy is really what matters for corporate Canada and the backdrop is pretty good. When the economy is expanding it’s generally a safe time to own corporate bonds. And yeah, GDP is going to be slower next year, but we’re still expecting that it’s going to be stronger than the post-financial crisis, pre-COVID period as the economy grew slowly. So that should mean decent corporate profits, meaning a less risky backdrop, companies making their coupon payments and re-financing any debt that they have coming up for maturity. That means we still expect corporate bonds to provide better returns than government bonds in 2022.

That doesn’t mean they’re going to blow the lights out, but it does mean that you want to focus on products that are heavier in corporate bonds than in government bonds. The extra yield that corporate bonds offer today is okay. For sure, it’s not cheap. I mean, corporate bonds spreads aren’t cheap, but nothing’s really cheap today. While we expect them to do better than government bonds, it’s modestly better. As an example, in the last three to five years, corporates have outperformed government bonds by about 1.5% per year. We think that could drop to about 1% in 2022. And we like more of the midterm area. So, that’s like five to 20 year area. We like the financials, autos, energy sector, corporate bonds as the better sectors to be involved in.

As far as risks go, there are always risks. I mean, COVID resurgence could lead to more lockdowns. Inflation could become more problematic than we expect, that could be an issue. China’s economy is slowing. It could have more than the consensus expect.

I mean, any of these could result in a flight to quality that sees government bonds favoured and credit spreads increasing. We don’t expect those are going to derail the broad outlook for the next year. And corporate bonds should continue to win the day.

And when we’re looking at the corporate bond market, we’re not talking just, we expect investment-grade corporate bonds to do better than government bonds. It’s the same story for the high yield sector. Now that’s been a very popular sector these last several years. As interest rates have been low, and more and more investors have been reaching for yield and they’re looking to the high yield sector – as some people call it the junk bond sector – for even higher yields than are available on investment-grade bonds. And we continue to expect that it’s a similar story to investment-grade corporate bonds whereas they’re not cheap either. The credit spreads on those have certainly been reduced, given the excessive demand.

We still expect that next year, the high yield is going to be the winner. It’ll beat government bonds and it’ll beat investment-grade corporate bonds. And if you think back, even though there’s talk about interest rates rising next year, that’s not necessarily anything that could really change the backdrop for which sector’s going to outperform. Generally, when government bond yields are rising, that’s usually indicative of the economy that’s doing okay. And maybe there’s a little inflation going on, which we certainly do see inflation elevated today in both Canada and the U.S. And generally what you see then, is that, that’s a good backdrop for corporate profitability, meaning that high yield bonds, high yield companies, companies that issue high yield bonds, those bonds will continue to be attractive to investors. They’ll perform well also. We might see those credit spreads increase a little bit. There should be some volatility that causes some opportunities to pick up or purchase some high yield bonds, even better yields what we’re seeing today. But regardless, we still expect the high yield sector to be leading the way in the next 12 months period.