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All's Down that Ends Down

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All's Down that Ends Down

I n a year that already provided a more challenging environment for the speculative-grade bond market than in recent years, December offered a final, painful end to 2015. The Federal Reserve finally raised the Federal Funds rate for the first time in nine years, but many believe this already was priced in by investors, given the large lead time and months' worth of hints via the Federal Open Markets Committee's (FOMC's) communications. Less expected was the sudden closure of one of the more well-known spec-grade bond mutual funds on December 11. That day the Dow Jones Industrial Average shed over 300 points, and the price of U.S.-traded crude oil experienced an 11% drop. By the end of the month, the S&P 500 lost 1.75%, investment-grade bonds lost 0.68%, and speculative-grade bonds shed a massive 2.8%.

In a year that already provided a more challenging environment for the speculative-grade bond market than in recent years, December offered a final, painful end to 2015. The Federal Reserve finally raised the Federal Funds rate for the first time in nine years, but many believe this already was priced in by investors, given the large lead time and months' worth of hints via the Federal Open Markets Committee's (FOMC's) communications. Less expected was the sudden closure of one of the more well-known spec-grade bond mutual funds on December 11. That day the Dow Jones Industrial Average shed over 300 points, and the price of U.S.-traded crude oil experienced an 11% drop. By the end of the month, the S&P 500 lost 1.75%, investment-grade bonds lost 0.68%, and speculative-grade bonds shed a massive 2.8%.

After facing so many challenges in December, both U.S. fixed-income and equity markets finished the year in negative territory (see chart 1). Through November, both investment-grade and speculative-grade bonds were experiencing losses for the year, while the S&P 500 was still positive. In the end, December proved to be the month that saw the worst losses for speculative-grade bonds since August 2011, when the ratings on the U.S. were downgraded, resulting in a loss of nearly 4% for the year. While the highest-rated bonds finished 2015 with gains, the overall investment-grade category also saw losses for the year, finishing down eight-tenths of a percent.

As expected, the Fed raised the target range for the Federal Funds rate by one quarter of a percentage point at its December meeting. While it is no surprise to see this result in losses for speculative-grade bonds, most of the losses during the month were prior the FOMC meeting (December 15), and the month was particularly harsh for speculative-grade bonds (see chart 2). The 'CCC/C' category lost 5.2% for the month alone, and 13.5% for all of 2015. Investment-grade bonds saw declines as well, with the 'BBB' category shedding over 1% in December. The losses for the 'AAA/AA' segment were barely noticeable, and, over the course of 2015, it was the only rating category to finish with positive returns, with a gain of 1.2%.

Yields on longer-dated Treasuries and investment-grade industrial bonds saw modest increases from the end of November, with relatively larger increases among the 'BBB' category (see chart 3). Yield movement among these safer assets was generally muted over December, as well. Interestingly, yields on 'AAA' and 'AA' industrials rose by less than yields on 10-year Treasuries: By the end of the month, the 'AAA' industrial yield rose by only four basis points, and the 'AA' industrial yield rose by five, compared with a six-basis-point rise in Treasuries. Unsurprisingly, speculative-grade industrial yields rose by a considerably greater extent (see chart 4). Notably, the five-year 'B' industrial yield is now flirting with the 13% mark, its highest level since June 2009 during the waning of the financial crisis. This rating category saw a 175 basis-point increase in December, over four times the 40 basis-point rise seen in 'BB+' industrial yields, highlighting the increased level of stress on the lowest-rated issuers recently.

December proved to be a particularly harsh month for financial markets, and any expectation of a positive correction in January has yet to show itself either. The S&P 500 lost nearly 2% in December, and fell another 6% in only the first five trading days of the new year. Global concerns over the health of the Chinese economy and equity markets have spilled over into the U.S., just as the Fed has started raising rates. For bond markets, the reaction has been less cringe-worthy, as investment-grade bonds have remained relatively flat, and speculative-grade bonds have lost only two-tenths of a percent. However, with so many challenges already in place, it is hard to imagine at this point that 2016 will be a good year for speculative-grade bond investors.