Corporate bonds will outperform the broad Canadian bond market after higher inflation and rising interest rates have widened spreads, a CIBC portfolio manager says.
Credit spreads between corporate and government bonds have moved materially wider this year, said Adam Ditkofsky, portfolio manager and vice-president at CIBC Asset Management, even as corporate earnings remain strong.
“The weakness has mainly been a reflection of reduced market risk appetite and not a deterioration of credit fundamentals,” Ditkofsky said in an interview last month.
Bond yields have risen sharply this year as markets become increasingly concerned about inflation and a policy error from central banks.
A large part of the weakness has been in short-term bonds of financial companies, which are some of the highest-quality corporate bonds in Canada, he said. A five-year senior bank bond recently traded 150 basis points wider than a Government of Canada bond — almost double where they were at the beginning of Q4 2021.
“This is normal to see,” he said, “as investors look to sell their most liquid corporate bonds when the market becomes stressed.”
Valuations for U.S. bonds also look more attractive, Ditkofsky said, but he’s also cautious about the spread widening further.
“High inflation, the war in Ukraine, potential Covid variants and the risk of a policy error from the Fed or the Bank of Canada all could cause spreads to widen, so we’re being careful with where we add,” he said.
Ditkofsky favours shorter dated corporate bonds, as they’re less sensitive to rising interest rates, and the financial sector in particular, which has already “experienced material widening” and is the most liquid part of the Canadian corporate bond market.
“You’re getting close to 4% on some of the highest quality corporate bonds available in Canada,” he said.
He also pointed to Canadian energy firms such as Suncor, Cenovus and CNQ that are benefiting from higher commodity prices. Overall, he said as long as companies still have pricing power and the economic landscape remains stable, the corporate bond market will continue to outperform. “It’s not without risk,” he said, but a lot of the widening has likely already happened.
Ditkofsky said the high yield market is a different story. High yield spreads haven’t moved out as materially, so “the sector hasn’t cheapened up as much.”
However, he said there are still some advantages to holding this sector, such as a low correlation with the broad bond market, but “the focus should be on bottom-up analysis.”
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