Other notable events include the market looking past the United States downgrade to AA by Fitch, however since the rating action, the yields for holding such debt have moved materially higher. Most market participants attributed the bear-flattening of the curve to prospects of deteriorating fiscal policy and a slew of treasury issuance in 2024 to meet the government’s spending needs. Over the third quarter, the 2s10s Treasury Curve was as deeply inverted as -108 on July 3 before steepening with the sharp rise in the 10-Year US Treasury yield over August and September closing the period -61 basis points inverted. The 5s10s and 10s30s credit curves also steepened yet, still ended inverted -11 and -26 basis points, respectively.

When taking stock of corporate fundamentals following the most recent earnings cycle, we witnessed weakened fundamentals across balance sheets and income statements. Most notably and of particular interest, debt levels and interest expense rose (not surprisingly) which pressured leverage and interest coverage metrics. However, interest costs remain low in historical context with corporations still benefiting from terming out their funding in the record low-rate environment of 2020-2021. Although the banking crisis is in the rear-view, the affects it had on markets is still one which credit markets are dealing with. In our view, most bank balance sheets still are well capitalized and have taken the appropriate measures to sure up liquidity should there be any future pull on liquidity. However, the pull back from Banks in extending credit is leading more issuers to seek funding in the private markets potentially lending to the supply/demand technicals. Away from idiosyncratic events and news, much of the move—or lack thereof—in terms of spreads on corporate debts we attribute to strong technical factors present in the market. One factor is the generic lack of issuance in the long end of the curve coupled with overwhelming demand from insurers, pensions and other long duration participants in the hopes of locking in higher coupons and yields. Another is the strong inflow of cash into bond funds with investors seeking to take advantage of the attractive all-in yields that were absent for a number of years.

Over the quarter excess returns were strong, largely supported by spread compression in July despite mild weakness in August and a relatively muted September. Office REITs carried strong performance over again as the sector was likely oversold on fears beyond challenges from “return to office” paradigms. As real estate sensitive sectors recovered from early weakness in 2023, the Insurance sectors of Life and Property and Causality notched positive excess returns over the period. The Energy sector and underlying subsectors experienced strength brought on by a resurgence in oil prices. More broadly throughout the course of the quarter, corporate credit outperformed non-corporates. Within the index, the Long Corporate segment (+2.18% excess) outperformed the Intermediate Corporate segment (+0.12% excess) and its shorter-dated counterparts, while BBB spreads tightened six basis points more than single-A credit.¹

Total supply in the third quarter was $286 billion, which was lower than the past four years average excluding 2020 of $297 billion. Most notably on the issuance front has been the lack of long-end issuance—adding a strong technical to the part of the market largely bought by insurers and pensions. With September bringing robust issuance following a summer slow down, the long-end only accounted for 10% versus a 16% average YTD. As expected, bond tender activity is down 54% year-over-year given the sharp rise in funding costs across the curve. Non-Financials have made up 61% of total supply, led by Healthcare (6.9% of YTD Supply) and Utilities (7.2% of YTD Supply) with a majority of the issuance purposes for M&A. We continue to see a similar theme in the third quarter where supply was heavily tilted towards the front-end in addition to A rated issuers accounting for 51% of supply, the largest percentage since 2000.²

The tug of war between the economic trajectory, corporate fundamentals, valuations and technicals has resulted in tighter spreads and flatter credit curves. The economy has largely shrugged off the over 5% of Fed hikes over the past 18 months, with unemployment still under 4% and inflation, while slowing, remains above the Fed’s target. Corporate fundamentals have been resilient. Defaults rates, while rising, remain low.

Economic bulls forecasting a soft landing are quick to point to the excess savings generated from easy money during the Covid period as supportive moving forward. We have certainly underestimated the staying power of the unprecedented stimulus, but with monetary policy decisively restrictive and many fiscal programs winding down, we have our eyes on cracks forming. High and rising delinquency rates on subprime loans without any significant uptick in unemployment indicates the effects of higher rates are certainly feeding into the lower rungs of consumer balance sheets. Combined with tight C&I lending standards, consumer strength is likely more fragile than economic data would suggest and the mere passing of time will continue to chip away at households and corporations.

For some time, we have felt the uncertain economic outlook amidst snug valuations warranted a defensive risk posture in portfolios and have leaned on security selection to offset the drag from our treasury allocation. We continue to believe we are steadily marching into the latest stages of the credit cycle, and ample liquidity from our credit underweight will eventually bear fruit with spread levels skewing risk to the downside. The at times frustrating technicals driving spreads tighter and curves flatter (minimal long dated supply, lack of secondary liquidity, market preference for on the run securities) have been a headwind to relative performance, but simultaneously provide opportunity for those willing to do relative value work down to the individual bond level. With that, it’s unlikely we make wholesale changes to the portfolio absent a material change in valuations, and instead will continue to refine positioning into sectors, issuers, and securities we believe hold long term value.

From an overall quality perspective, we continue to favor BBB credit improvement stories vs single-A and better paper, which been tremendously supported from a lack of high-quality supply in the higher yield environment. Within BBB, we believe successfully identifying improvement stories in low BBB names and avoiding downgrades will be paramount in differentiating excess return as the credit cycle turns. From a sector perspective, we continue to favor less cyclical sectors like Healthcare, Pharmaceuticals, Aerospace Defense and Utilities and also favor less cyclical names within more cyclically oriented sectors (i.e. gold names in Metals & Mining). We remain overweight Banking and continue to favor the front end of the curves as a defensive way to maintain a healthy yield advantage.

Technicals have been powerful this year, and with that in mind we continue to closely monitor the supply outlook given its highly correlated impact on spreads this year. Opportunistic issuance in 30-year space has all but vanished and M&A outside of Healthcare and Pharma has also dried up. What little 30-year issuance we have seen has come at levels at or through secondary bonds and flat to shorter duration credit spreads, which we do not believe appropriately compensates investors for lending to companies for longer. While we broadly remain concerned about valuations, we do concede the symmetry of outcomes is far more balanced on the intermediate part of the curve relative to the long end, and that is where we have chosen to bias our credit curve positioning within portfolios.

For those client portfolios that allow for high yield exposure, we remain extremely selective in our positioning, with nearly the lowest allocation since inception. It is extremely difficult to find instances where high yield would outperform investment grade credit in the risk-off environment that we have envisioned this year. Time decay to 2025 maturity walls only further emboldens our call for decompression from extremely tight levels to IG credit. Default rates will rise as less resilient business models are pressured by higher interest rates, and that is a not a risk we want to introduce to investment grade portfolios.

Like a toddler on a long road trip, our positioning for an economic dustup and repricing of risk assets (that seem to never arrive) often begs the rhetorical question, “Are we there yet?” While we cannot point to the exact catalyst or timing for spread widening, we firmly believe the path of spreads to be wider and curves steeper in an unwind of the stalwart and supportive technicals that have diverged valuations from forward fundamentals. We will continue to carry a treasury balance to take advantage of this eventuality and will look to refine and reposition the portfolio along the way. Solid carry and positive security selection are dependable tools by which to generate alpha, though we would welcome a back-up in spreads which would provide a far more robust opportunity set.

Endnotes
¹ Bloomberg
² JP Morgan 

Disclaimer
This material is intended solely for Institutional Investors, Qualified Investors and Professional Investors. This analysis is not intended for distribution with Retail Investors.
This document has been prepared by MetLife Investment Management (“MIM”)1 solely for informational purposes and does not constitute a recommendation regarding any investments or the provision of any investment advice, or constitute or form part of any advertisement of, offer for sale or subscription of, solicitation or invitation of any offer or recommendation to purchase or subscribe for any securities or investment advisory services. The views expressed herein are solely those of MIM and do not necessarily reflect, nor are they necessarily consistent with, the views held by, or the forecasts utilized by, the entities within the MetLife enterprise that provide insurance products, annuities and employee benefit programs. The information and opinions presented or contained in this document are provided as of the date it was written. It should be understood that subsequent developments may materially affect the information contained in this document, which none of MIM, its affiliates, advisors or representatives are under an obligation to update, revise or affirm. It is not MIM’s intention to provide, and you may not rely on this document as providing, a recommendation with respect to any particular investment strategy or investment. Affiliates of MIM may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives) of any company mentioned herein. This document may contain forward-looking statements, as well as predictions, projections and forecasts of the economy or economic trends of the markets, which are not necessarily indicative of the future. Any or all forward-looking statements, as well as those included in any other material discussed at the presentation, may turn out to be wrong.
All investments involve risks including the potential for loss of principle and past performance does not guarantee similar future results. Property is a specialist sector that may be less liquid and produce more volatile performance than an investment in other investment sectors. The value of capital and income will fluctuate as property values and rental income rise and fall. The valuation of property is generally a matter of the valuers’ opinion rather than fact. The amount raised when a property is sold may be less than the valuation. Furthermore, certain investments in mortgages, real estate or non-publicly traded securities and private debt instruments have a limited number of potential purchasers and sellers. This factor may have the effect of limiting the availability of these investments for purchase and may also limit the ability to sell such investments at their fair market value in response to changes in the economy or the financial markets.
In the U.S. this document is communicated by MetLife Investment Management, LLC (MIM, LLC), a U.S. Securities Exchange Commission registered investment adviser. MIM, LLC is a subsidiary of MetLife, Inc. and part of MetLife Investment Management. Registration with the SEC does not imply a certain level of skill or that the SEC has endorsed the investment advisor.
This document is being distributed by MetLife Investment Management Limited (“MIML”), authorised and regulated by the UK Financial Conduct Authority (FCA reference number 623761), registered address 1 Angel Lane, 8th Floor, London, EC4R 3AB, United Kingdom. This document is approved by MIML as a financial promotion for distribution in the UK. This document is only intended for, and may only be distributed to, investors in the UK and EEA who qualify as a “professional client” as defined under the Markets in Financial Instruments Directive (2014/65/EU), as implemented in the relevant EEA jurisdiction, and the retained EU law version of the same in the UK.
For investors in the Middle East: This document is directed at and intended for institutional investors (as such term is defined in the various jurisdictions) only. The recipient of this document acknowledges that (1) no regulator or governmental authority in the Gulf Cooperation Council (“GCC”) or the Middle East has reviewed or approved this document or the substance contained within it, (2) this document is not for general circulation in the GCC or the Middle East and is provided on a confidential basis to the addressee only, (3) MetLife Investment Management is not licensed or regulated by any regulatory or governmental authority in the Middle East or the GCC, and (4) this document does not constitute or form part of any investment advice or solicitation of investment products in the GCC or Middle East or in any jurisdiction in which the provision of investment advice or any solicitation would be unlawful under the securities laws of such jurisdiction (and this document is therefore not construed as such).
For investors in Japan: This document is being distributed by MetLife Asset Management Corp. (Japan) (“MAM”), 1-3 Kioicho, Chiyodaku, Tokyo 102-0094, Tokyo Garden Terrace KioiCho Kioi Tower 25F, a registered Financial Instruments Business Operator (“FIBO”) under the registration entry Director General of the Kanto Local Finance Bureau (FIBO) No. 2414.
For Investors in Hong Kong S.A.R.: This document is being issued by MetLife Investments Asia Limited (“MIAL”), a part of MIM, and it has not been reviewed by the Securities and Futures Commission of Hong Kong (“SFC”). MIAL is licensed by the Securities and Futures Commission for Type 1 (dealing in securities), Type 4 (advising on securities) and Type 9 (asset management) regulated activities.
For investors in Australia: This information is distributed by MIM LLC and is intended for “wholesale clients” as defined in section 761G of the Corporations Act 2001 (Cth) (the Act). MIM LLC exempt from the requirement to hold an Australian financial services license under the Act in respect of the financial services it provides to Australian clients. MIM LLC is regulated by the SEC under US law, which is different from Australian law.
MIMEL: For investors in the EEA, this document is being distributed by MetLife Investment Management Europe Limited (“MIMEL”), authorised and regulated by the Central Bank of Ireland (registered number: C451684), registered address 20 on Hatch, Lower Hatch Street, Dublin 2, Ireland. This document is approved by MIMEL as marketing communications for the purposes of the EU Directive 2014/65/EU on markets in financial instruments (“MiFID II”). Where MIMEL does not have an applicable cross-border licence, this document is only intended for, and may only be distributed on request to, investors in the EEA who qualify as a “professional client” as defined under MiFID II, as implemented in the relevant EEA jurisdiction. The investment strategies described herein are directly managed by delegate investment manager affiliates of MIMEL. Unless otherwise stated, none of the authors of this article, interviewees or referenced individuals are directly contracted with MIMEL or are regulated in Ireland. Unless otherwise stated, any industry awards referenced herein relate to the awards of affiliates of MIMEL and not to awards of MIMEL.
¹ As of March 31, 2023, subsidiaries of MetLife, Inc. that provide investment management services to MetLife’s general account, separate accounts and/or unaffiliated/third party investors include Metropolitan Life Insurance Company, MetLife Investment Management, LLC, MetLife Investment Management Limited, MetLife Investments Limited, MetLife Investments Asia Limited, MetLife Latin America Asesorias e Inversiones Limitada, MetLife Asset Management Corp. (Japan), MIM I LLC, MetLife Investment Management Europe Limited, Affirmative Investment Management Partners Limited and Raven Capital Management LLC.