US Credit Update – Bright Spots in Utilities

Highlights from U.S. credit markets last week:

  • Utilities outperform as Treasuries find their footing
  • Consumer staples, financials lead new issuance
  • PCs, semiconductors outperforming among tech sector
  • Gas distributors underperforming in 2018
  • Bright spots in utilities

Utilities outperform as Treasuries find their footing

Treasuries and other safe assets found their footing last week and high yield lagged. The Bloomberg Barclays investment-grade utility index was the best performer on the week, rising 0.5%. Financials were flat on the week.

The outperformance of utilities over financials was expected to accompany a modest turn in Treasury yields. We’ve been highlighting for a few weeks the tendency for utilities to outperform financials when Treasury yields are falling. The scatter plot below shows 22-day changes for the Bloomberg Barclays Treasury total return index versus the difference between total return changes for the Bloomberg Barclays Financial and Utility indices. The latest point is right on the trendline since 2009. Continued declines in Treasury yields are likely to see longer duration utilities keep outperforming financials.

Consumer staples, financials lead new issuance

Primary market activity remains a bit sleepy with volatility still elevated. A sustained drop in Treasury yields could see opportunistic issuers return in greater numbers. Our corporate trader had the following summary on Friday of the week’s activity:

New issue volume continues to be slow in March. Without last week’s $40 billion CVS deal, there has only been $43 billion priced during the first half of the month. The best performers this week were a 7 and 10-year from SPRNTS, and the 5 and 10-year priced by MCD. A multi-tranche deal priced by CPB struggled in the secondary market even before being freed to trade. The 10-year tranche closed the week +10 basis points, while 5s and 7s closed +5-7 basis points. The market for new issue paper remains quite fickle. It was a tough week for new issuance in the Yankee bank sector. STANLN priced 6 and 15-year maturities that backed up 9-13 basis points. CBAAU printed a 5-year that backed up 7 basis points.

 Dealers sold marginally more bonds to clients than they bought amid volumes slightly below average. Financials, energy and health care were the most active sectors. TMT was for sale much of the week, but short covering was seen during Friday’s session as spreads moved back in. 

Financials and consumer sectors were most active in the primary market. McDonalds, Campbell Soup, and Caterpillar were among the better-known names with larger deals.

PCs, semiconductors outperforming among tech sector

TMT may have been under some pressure last week but the technology sector has been the top performer on a spread basis over the last month. The chart below shows average 1-month changes in spread to benchmark Treasuries, by sector, for issues in the Bloomberg Barclay’s industrial index. The x-axis shows duration in 2-year bins. Spreads have widened across the board, of course, but technology spreads have been the most resilient along the entire curve.

On a total return basis for 2018, PC-makers and semiconductor manufacturers have been the top performers. The chart below shows year to date total returns for tech sector issues in the industrials index. Dell and HPQ have led among PC-makers. Broadcom and Qualcomm, which have just called off a potential merger, are the top performers in semiconductors.

Gas distributors underperforming in 2018

The Wall Street Journal had an article over the weekend noting that political winds have begun to shift against natural gas in many states. The chart below shows natural gas distribution utility issues have been among the worst performers in 2018 among the Bloomberg Barclay’s utility index. The chart shows year to date returns by duration with mark size reflecting the total par value of the issue. Though behind integrated electric issues, gas distribution is among the larger components of the index and has dragged down overall returns this year. The long duration, with a heavy concentration over 12 years, has not helped with Treasury yields rising. The duration will become a tailwind though if Treasuries can sustain a rebound.

Bright spots in utilities

There are some brighter spots among utilities though. Integrated electric utilities are the largest industry subgroup and have seen widely varied performance in 2018. The chart below shows year to date total returns by duration for integrated electric utility issues over $1 billion in size. Excelon and First Energy are among the best performers on average. FirstEnergy has outperformed their duration matched peers by 1-2%.

Last week saw some issuers begin to break away from the pack on a spread basis. The last chart shows the average change in the spread to benchmark Treasury, by issuer and limited to issues over $1 billion in size. Pacific Gas and Electric and Dominion Energy saw spreads tighten on the week.

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