Earnings trends supportive of investment-grade credit

Key takeaways

• Investment-grade (IG) companies' earnings continued to exceed consensus expectations, with a broadening of the recovery beyond the technology sector expected to build over the rest of the year. 
• Current yields are attracting cash flows into IG, which—along with lower expected issuance for the second half of 2024—are providing technical support for the IG corporate market.
• Tight IG credit spreads over Treasuries remain justified as long as the economy remains strong and yields elevated.

A broadening earnings recovery among IG corporates and a favorable technical environment offer a positive environment for the IG credit market, even if credit spreads are tight.

Earnings in the first quarter were driven by productivity gains, particularly strong operating leverage, and cost-cutting. The technology and communication services sectors saw the best performance while energy and materials lagged.

Three-quarters of S&P 500 companies beat analysts’ estimates by an average of 7%, and market consensus expects an earnings recovery for the S&P 500 Index beyond technology in the rest of 2024 and through 2025.

A sales rebound?

Skeptics might point out that sales expectations have been underperforming profit estimates. Historically, we have seen similar underperformance during recessions or periods of heightened growth fears.

However, several sectors have already experienced separate earnings recessions, including technology in 2022 and some cyclicals in 2023. The bond market’s recent shift in expectations to the proverbial soft or no-landing scenario—in which the Federal Reserve’s restrictive rate policy does not end up causing a recession——indicates sales may rebound, further supporting current IG corporate bond valuations.

Consumer health: We see a clear bifurcation between high- and low-income cohorts, as low-income households show signs of increasing stress related to high inflation and higher interest costs. However, despite low-income consumers trading down and changing some behaviors, on balance, U.S. consumer spending remains solid, helped by abating inflation pressures. 

Capital expenditures: Corporations are allocating more dollars to investment, which may speak to richer equity valuations and highlights the idea that companies see higher returns from investment than stock buybacks. Much of the growth in CapEx is being driven by hyperscalers (such as Microsoft, Amazon, Google, and Meta) investing in artificial intelligence.  

Technical tailwinds: Issuance in 2024 has been front-loaded, with two-thirds of full-year issuance expectations completed through mid-June and expected to decline as the year progresses. Meanwhile, IG corporate paper was still yielding 5% or higher as of mid-June, with BBB yields above 5.5%. (Bloomberg data as of June 24, 2024.) Combined with declining issuance, these attractive yields should provide tailwinds through year-end.
 

Looking for opportunity

With all-in yields at attractive levels and positive underlying corporate fundamentals, IG credit is a more attractive asset allocation lever than it has been in some time. While spreads are toward the tight end of their historical range, they can remain range-bound so long as fundamentals continue to be supportive.

Related mutual funds/ETFs:

Vanguard Core Bond Fund (VCOBX)

Vanguard Core Bond ETF (VCRB)

Vanguard Core-Plus Bond Fund Admiral Shares (VCPAX)

Vanguard Core-Plus Bond ETF (VPLS)

Vanguard Multi-Sector Income Bond Fund (VMSAX)

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