Previous Equity Drawdowns Had a Credit Dynamic…Until Now

Kurt Kringelis

Kurt Kringelis, CFA, CPA, JD

Head Macro Credit Strategist

The first quarter of 2018 marked the return of volatility to financial markets. Fixed income was not immune from these swings. The increase in U.S .Treasury yields can be traced back to late 2017, when rising inflation expectations set the stage for a massive spike in implied volatility, with the VIX index leaping from 10% to 37% in just ten days. This confluence of events drove equity markets down and large swings have continued throughout 2018. Although a sudden change from recent behavior, the increase in volatility was a return to normal for financial markets.

Are we cautious in the current market environment? Absolutely—it’s certainly not the time to max out risk budgets. However, it is important to note that while we are indeed cautious, we are not overly bearish. In another change — here from precedent — equity downturns this year have not led to wider credit spreads (Figure 1). Indeed, the degree of spread widening and underperformance for corporate credit in Q1 was rather muted compared to previous equity corrections since the global financial crisis. When equities sold-off in late January, investment grade spreads barely reacted – widening by just 2 basis points. Investment grade corporate bond spreads continued to drift wider for the balance of the quarter in response to announcements of U.S. trade tariffs and rising concerns of the threat of a trade war.

This breakdown between equity market volatility and credit spread volatility is a positive sign for fixed income investors as it indicates that credit fundamentals remain largely intact. The recent volatility has also led to increased dispersion among industries and issuers, creating opportunities for fixed income investors. In this environment, security selection remains key as idiosyncratic risks among issuers are being magnified.

Figure 1. Correlation Between Equities and Credit Spreads Breaking Down

Figure 1. Correlation Between Equities and Credit Spreads Breaking Down

As of March 23, 2018. Source: Bloomberg, Barclays Bloomberg and Voya Investment Management

S&P 500 returns represented as all drawdowns of at least 10% from 01/01/2010 – 12/31/2017, plus drawdowns in Q1 2018. IG Spread changes as represented by option adjusted spread (OAS) change for the Bloomberg Barclays Corporate Bond Index.

Past performance does not guarantee future results. 

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