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Equity markets dropped this week as volatility returned—causing some investor pain—but corporate bonds experienced “comparative calm,” a Moody’s Analytics report says.

Read: As markets drop, here’s how advisors are communicating

In the Feb. 8 report, Moody’s Analytics chief economist John Lonski says “the corporate credit market has been relatively steady amid equity market turmoil.”

One reason is that there are “expectations of continued profit growth that underpins a still-likely slide by the high-yield default rate,” he wrote. “The record shows that 90% of the year-to-year declines by the default rate were joined by year-to-year growth for the market value of U.S. common stock.”

Read: The case for high-yield bonds amid rising rates

The outlook for equities going forward is also positive, he says, given the “outlooks for business sales and operating profits suggest that equities will recover once issues pertaining to interest rates are sufficiently resolved.”

In the meantime, however, “equities may be paying dearly for having been more richly priced vis-a-vis fundamentals […],” says Lonski.

Year-to-date, the S&P/TSX Composite Index is down 7.06%. However, if you look out three, five and 10 years, this week’s performance was a minor blip. The S&P 500 has returned -3.46% year-to-date, but has also performed well over the longer term.

Read: Is the bull run over for U.S. equities?

The normally positive correlation between the high-yield bond spread and the VIX index broke down, this week, Lonski says. “Never before has the high-yield bond spread been so unresponsive to a skyrocketing VIX index.”

Lonski is keeping an eye on the bond and equity markets, in a environment where interest rates are rising and inflation is a concern. He’s monitoring equity performance versus fundamentals as well as whether the high-yield bond spread is reacting to Treasury bond yield activity.

Read the full Moody’s report.

Also read:

Where to watch U.S. corporates

Equity returns, rate hikes and risks: experts weigh in

Originally published on Advisor.ca
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