This market chart was originally written by Andrew Osterback, Director and Portfolio Manager, Fixed Income Canada for BMO Global Asset Management (Canada).
As we all know, the stock market has been performing well for quite some time. As stocks experience solid performance, typically corporate bonds do as well; not surprising, as the factors that contribute to solid equity performance – corporate profitability, low interest rates and stable inflation – also help the corporate bond sector. At the same time, as we extend further into the economic cycle, the performance between stocks and bonds can start to diverge. The equity market can continue to experience solid gains, while the corporate sector of the bond market begins to struggle. As a guide, the S&P 500 has returned approximately 16% over the last 12 months, while U.S. corporate bond spreads have actually widened, albeit a reasonably modest 10 bps.
It’s important to note that as we’ve experienced this divergence between stock and corporate bond performance, we’ve also seen equity volatility (as measured by the S&P 500 VIX Index) decline towards historic lows.
This chart also demonstrates that not only are we near all-time lows for the VIX, corporate spreads are also relatively low. As a result, we have a situation where risky assets (stocks) have been performing well for quite some time, volatility is low and corporate spreads (the compensation for taking on credit risk in the corporate sector) are relatively narrow. Given the environment, we don’t feel that investors are being adequately compensated for the risks inherent in corporate bonds.
The S&P 500 Index is a capitalization-weighted index of 500 large-cap U.S. stocks.
VIX Index — The Chicago Board Options Exchange Market Volatility Index is a measure of implied volatility of S&P 500 Index options, often referred to as the “fear” index.
Investments cannot be made in an index.