1Q26_ Quarterly Outlook Report_Final_EN - Flipbook - Page 143
T H E P LUMB LI N E | A RETU RN TO F I RS T PRI N CI PL ES
Credit fundamentals remain stable to slightly improving, though generally leaning to the weaker
side. Leverage metrics for the investment grade index improved broadly in 3Q25, with total debtto-EBITDA at the lowest levels in the past two years. Interest coverage (EBIT/Interest expense)
improved marginally, pushing off 20-year lows. High yield leverage moved higher for two quarters
in a row, but remains well below 2020 and 2023 highs, while interest coverage has remained firmly
below the decade norms.
For positioning, we prefer long duration relative to corresponding benchmarks to take advantage
of the U.S. yield curve potentially shifting lower. Assuming few surprises from U.S. Treasury supply,
an as-expected corporate issuance and maturity calendar, combined with “ok” fundamentals
continue to unpin steady demand for corporate credit with attractive all-in yields. Within credit,
we continue to favour higher quality investment grade credit (‘A’-rated and above) over high yield,
preferably in the short-to medium part of the yield curve. With spread valuations continuing to
test historical lows, this is a credit-pickers market.
Investment grade corporate debt: performance stalwart should carry into 2026 as AI funding
ramps
Investment grade (IG) corporate debt delivered solid returns in 2025 as risk assets swung on
developments around Trump’s tariff policy from the peak of volatility in April. Within the U.S. high
grade universe, ‘BBB’s led all-rating sectors performance (+7.9%), supported by resilient balance
sheets and declining nominal rates that pushed spreads toward historical tights (approximately
78 bps) on the total index.
The Bloomberg U.S. corporate bond index currently yields 4.85%, above the five-year average but
below the mid-October 2023 peak. Looking ahead to 2026, with UST yields likely trending lower
from a supportive FOMC, investors will likely continue searching for incremental carry. At current
spread levels (‘AAA’ ~33 bps vs. ‘BBB’ ~98 bps), ‘BBB’s offer a more compelling premium,
suggesting demand may remain sticky.
However, we caution that at these levels, credit/issuer selection is key and for investors not to
pursue ‘a one size fits all’ passive strategy. Additionally, a steeper nominal curve driven by higher
long end yields could pressure IG valuations and increase the odds of spread widening, potentially
toward the 100 bps area at the index level, regardless of underlying credit quality. While the
incremental carry appears compelling in ‘BBB’s, we prefer to play defense in higher quality in ‘A’s
and above.
One sector that is worth highlighting is technology which is increasing its importance within the
U.S. IG market. The sector currently comprises approximately 8% of the Bloomberg U.S. Corporate
index and we see scope for its weight to increase as issuance accelerates. The sector sits at the
center of the AI capex cycle with such mega caps as Amazon, Meta, Alphabet, and Microsoft having
balance sheet capacity to fund capital expenditures, but the key question remains the
monetization of this investment. For credit investors, analysis of leverage trajectories, interest
coverage durability, and the expected return on investment from AI-related spending remains
critical.
142
