Fourth Quarter Comeback Bid Falls (Very) Short
The bond market ended the year with its best quarterly return in over two years. While this fourth quarter comeback was welcome relief, it was not enough to pull the Bloomberg U.S. Aggregate Bond Index (the Agg) out of its worst calendar year in history. For the quarter, the Agg was up 1.87% and gains were strong across the board. Corporate bond spreads tightened across every investment grade (IG) sector, and riskier bonds (BBBs) were the best performer in the IG space. Every Agg sub-component posted positive absolute returns. In the high yield (HY) space, spreads tightened in every sector but one (Technology), and the default rate remained low by historical standards. BB and B rated HY bonds posted strong gains, while CCCs underperformed. Municipal bonds also performed well in the quarter, with longer-duration munis outperforming shorter duration.
By any measure, 2022 was a remarkable outlier. The Agg declined by 13.0%, the previous worst-ever mark being -2.9% in 1994. The decline in high yield of over 11% was the second-worst in history. Given the magnitude of rate increases implemented by the Federal Reserve (Fed) over the year, it is no surprise that duration was pummeled, as long Treasuries lost 33% and long corporates lost 26%. Looking ahead, the Fed’s work is not over, and the market is currently pricing in two more quarter-point rate hikes. Recent Fed speakers have emphasized the “higher rates for longer” message, and most economists believe the economy will enter something resembling a recession in 2023. That said, the fixed income market enters the new year with more of a yield cushion than existed this time one year ago, and that will be a moderating factor to any further potential rate increases. Please read on for more details from the final quarter of a bruising year.
Market Summary
Returns were positive across most of the fixed income landscape in the fourth quarter, a welcome rebound from three consecutive quarters of losses.
U.S. Treasury Market
The Fed’s efforts resulted in higher Treasury yields on the short end. Yields rose on the long end to a lesser degree and fell in the belly of the curve.
Short Treasuries continue to benefit from higher yields, while returns were worse further out the curve. Full-year 2022 returns were among the worst on record.
Broad Investment Grade
All components of the Agg were positive on an absolute basis in the quarter, led by the rebound in long corporates. For the full year, not a single component outperformed Treasuries.
Corporate bond spreads tightened in the quarter, as did mortgage-backed security spreads.
Absolute and excess (relative to Treasuries) returns were positive across all investment grade quality categories, with riskier BBBs and As outperforming AAs and AAAs.
Corporate spreads tightened somewhat uniformly across all sectors.
High Yield
High yield returns were strong in the quarter, and all but CCCs posted positive excess returns. For the full year, high yield corporates outperformed investment grade.
Relative to their investment grade counterparts, high yield sector spreads exhibited much more volatility. Technology sector spreads widened slightly, while every other sector tightened, led by the Consumer Cyclical sector.
The high yield default rate ticked slightly higher in the quarter but remains quite low versus historical levels.
Municipals & Other
Municipals were a strong performer for the quarter, and one of the leaders for the full year compared to other corners of the fixed income market.
Emerging market bonds rebounded sharply in the fourth quarter. Leveraged loans were also a strong performer for the full year, benefiting from their typical floating coupon structure.
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This update provides an overview of certain broad-based Fixed Income benchmarks and does not include performance of the Segall Bryant & Hamill Fixed Income styles. Past performance cannot guarantee future results. All investments involve risk, including the possible loss of capital. All opinions expressed in this material are solely the opinions of Segall Bryant & Hamill. You should not treat any opinion expressed as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of the manager’s opinions. The opinions expressed are based upon information the manager considers reliable, but completeness or accuracy is not warranted, and it should not be relied upon as such. Market conditions are subject to change at any time, and no forecast can be guaranteed. Any and all information perceived from this material does not constitute financial, legal, tax or other professional advice and is not intended as a substitute for consultation with a qualified professional. The manager’s statements and opinions are subject to change without notice, and Segall Bryant & Hamill is not under any obligation to update or correct any information provided in this material.
1 Source: Bloomberg.
2 Source: Bank of America Merrill Lynch.
3 Hypothetical yields are calculated as the AA municipal yield divided by (1-tax rate). Actual tax-adjusted yields will depend on individual tax circumstances.
4 Source: Standard & Poor’s.