As the economic recovery from the Covid-19 pandemic stumbles on, corporate bonds are “flashing a healthy signal for investors,” says Patrick O’Toole, vice-president of global fixed income with CIBC Asset Management.
Corporate bonds should continue to outperform government bonds, even in the face of inflation and the prospect of higher interest rates, O’Toole said.
“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,” he said in a Nov. 25 interview.
Over the last three to five years, corporates have outperformed government bonds by about 1.5% per year, said O’Toole, who manages the Renaissance Corporate Bond Fund.
That outperformance could drop to about 1% next year, he said. His team likes bonds in the five- to 20-year range, specifically in the financial, auto and energy sectors.
“The economy is really what matters for corporate Canada and the backdrop is pretty good,” O’Toole said.
While GDP growth is likely to slow from this year’s pace, he expects it to remain higher than in the period between the financial crisis and Covid. Decent corporate profits will make for a less risky backdrop, he said, as companies make their payment coupons and refinance the debt coming up for maturity.
“Corporate bond spreads aren’t cheap, but nothing’s really cheap today,” he said.
Covid continues to present a risk, and any further lockdowns could hurt companies’ bottom lines. O’Toole was speaking on Nov. 25, a day before markets tanked and government bond yields sank in response to the World Health Organization declaring omicron a “variant of concern.”
Global corporate bonds were either flat or lower in November, while government bonds rallied on concerns about the omicron variant, a monthly insight report from FTSE Russell said. Canadian high-yield remained the top performer, up nearly 6% year to date despite a flat month.
O’Toole said he expects high-yield bonds will continue to outperform. Higher interest rates won’t necessarily be a headwind, he said, as central bank tightening is generally a sign of a strong economic backdrop and corporate profits.
Although excessive demand for yield has reduced credit spreads, those spreads might increase a little bit next year. Volatility could also create opportunities to purchase high-yield bonds with better yields than what’s available now.
“Regardless, we still expect the high-yield sector to be leading the way in the next 12-month period,” O’Toole said.
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