Bond investors experienced another eventful year in 2023. From market volatility, to economic uncertainty, to geopolitical tensions around the world, a wide range of events continued to influence fixed income asset classes, including high-yield corporate bonds. As a result, market participants paid close attention to these, along with a number of key factors that drive bond values and yields. Among them were the state of the U.S. economy, inflation data, as well as federal monetary policy and the direction of interest rates.
Through it all, high-yield bonds recorded strong returns in 2023. High-yield corporate bonds, as measured by the Bloomberg® US Corporate High Yield Bond Index, generated a total return of 13.44% for the year. Yet, as we proceed into 2024, some investors are a bit uncertain, wondering if the momentum will continue, or if market conditions may change. So, let’s take a look at some important factors driving the fixed income markets, including high-yield bonds.
Key Market DriversÂ
The Federal Reserve (the “Fed”) continues to exert its influence on the financial markets. In an attempt to manage economic growth, inflation, and at the same time, avoid triggering a possible recession, the Federal Reserve has been focused on controlling the level of interest rates. The Fed’s “tight” monetary policy, which began in March of 2022 with a series of increases in the federal funds rate (the interest rate that banks charge each other to borrow or lend excess reserves overnight), seems to have entered into more of a holding pattern for the time being. Following a period that included 11 consecutive rate hikes, the Fed has elected to push pause, leaving the federal funds rate unchanged at each of the last four Federal Open Market Committee meetings (through January, 2024). Although the Federal Reserve previously suggested it would consider adopting more of an “easing” monetary policy and possibly begin lowering interest rates in 2024, Fed Chair Jerome Powell has now said that future decisions will be made on a meeting-by-meeting basis, and will be heavily dependent on key economic data.
There are many questions and unknowns at the present time. For instance, will the Fed’s monetary policy ultimately be enough to successfully guide the economy to a so-called “soft landing?” Or might it not find the precise formula to do so and possibly risk the economy falling into a recession?
Fixed income asset classes, including high-yield bonds, are historically sensitive to certain factors that influence the economy, financial markets, and specific issuers of securities and their industry sectors. One such indicator is the level of inflation, which has had a major influence on the U.S. economy, including higher costs for consumers, as well as tighter profit margins for many businesses. It appears that, after recently reaching decades-high levels, inflation has settled lower and is more in line with where the Federal Reserve would prefer to see it. Inflation, as measured by the Consumer Price Index (“CPI”), rose as high as 9.1% in June of 2022. After beginning 2023 with a year-over-year increase of 6.4% in January, the CPI steadily worked its way lower, ultimately closing the year at a rate of 3.4% in December. Going forward, the Fed has indicated its intention to further reduce the inflation rate to a target range of 2.0%.
Other important economic and market drivers, such as employment data and corporate earnings have generally been encouraging, providing somewhat of a pleasant surprise to the financial markets. However, there have been several segments of the economy, including housing, manufacturing, and some consumer-oriented segments, that have shown some signs of weakness — while at the same time, other segments, such as services, may not have experienced it to the same degree. Thus, some economists are cautioning about a so-called “rolling recession” across certain economic sectors. Investors will likely also keep a watchful eye on these and other leading economic indicators.
And it’s not only about how the U.S. economy fares. Especially in today’s growing global economy, events related to macroeconomic and geopolitical conditions around the world can have powerful and broad-reaching influence. For example, the troubling developments in the Middle East and potential for further escalation, along with the ongoing conflict in Ukraine, continue to cast a cloud of uncertainty over the global economy. Could such factors have an impact on energy prices, the cost of certain goods and services, among others, and possibly lead to lingering inflationary pressures? This, of course, remains to be seen. Suffice to say, there are numerous factors driving fixed income markets, which investors continue to pay attention to.
Additional Context and Considerations
Throughout a somewhat volatile year, the high-yield bond market generally demonstrated impressive resiliency. On a relative basis, high-yield outperformed many of its cohorts, as investors expressed a willingness to adopt more of a “risk-on” sentiment, attracted by higher yields and firmer credit fundamentals. The 13.44% total return generated by the Bloomberg® US Corporate High Yield Index exceeded that of the investment-grade corporate bond market, as measured the Bloomberg® US Corporate Bond Index (+8.52%). It also beat the return of the broad-based intermediate-term bond market, which is tracked by the Bloomberg® US Aggregate Bond Index (+5.53%), as well as that of U.S. Treasury bonds, as measured by the Bloomberg® US Treasury Total Return Index (+4.05%).
An encouraging sign for the high-yield market was a significant increase in new issuance during 2023. According to J.P.Morgan Credit Research, high-yield corporate bond issuance totaled $175.9 billion last year, which represented a 65% jump from issuance in 2022. Although considered relatively light on a historical basis, these figures indicate a desire by many issuers to re-engage and capitalize on changing market dynamics. Not surprisingly, most of the issuance was related to refinance activity, as companies appeared to strategically manage upcoming debt maturities in 2024 and 2025.
As volatility lingers, and concerns related to certain macroeconomic and geopolitical issues persist, the investment team that manages Aquila Group of Funds’ high-yield strategy continues to follow a disciplined investment and research process. Combining a “top-down” and “bottom-up” approach, the investment management team searches the entire high-yield universe — with no restriction on particular sectors — for opportunities they believe offer above-average relative value and meet stringent credit analysis requirements. They painstakingly seek fiscally responsible corporate management teams that are committed to growing operations prudently, and who recognize they can potentially improve their credit profile by focusing on company-specific measures.
Looking Ahead
One thing that is certain in the financial markets is uncertainty. That’s why we believe investors should maintain a long-term perspective, and we encourage investors to consult with a financial professional who can help them develop an asset allocation model and diversified portfolio. Although market volatility and changing economic conditions may trigger uncertainty or concern, we caution investors to try to avoid making emotionally-based decisions. Rather, we feel it’s critically important to keep in mind your personal investment objectives and long-term financial goals.
The investment team dedicated to Aquila High Income Fund employs a comprehensive investment and research process, designed to maximize current income, with a secondary objective of capital appreciation. With more than 100 years of combined experience, our seasoned investment professionals actively manage the Fund with a goal to identify opportunities, continually seeking to maximize return potential while, at the same time, managing market risks.
Since 1984, Aquila continues to take a careful approach for today’s markets. As we celebrate our 40th year of serving investors and financial professionals, we believe this is particularly important, perhaps more so now than ever — which is why Aquila Group of Funds maintains a long-term view and remains firmly grounded in our organization’s Guiding Principles.
This information is general in nature and is not intended to provide investment, accounting, tax or legal advice, nor is it intended to represent a recommendation or solicitation related to any particular investment, security or industry sector. Market and economic conditions are subject to change.
The Bloomberg® US Corporate High Bond Yield Index is an unmanaged index considered representative of the universe of fixed-rate, non-investment-grade debt. The Bloomberg® U.S. Aggregate Bond Index is is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The Bloomberg® US Treasury Total Return Index measures U.S dollar-denominated, fixed-rate, nominal debt issued by the U.S. Treasury. An investment cannot be made directly in an index. Past performance does not guarantee future results.
BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Bloomberg does not approve or endorse this material or guarantee the accuracy of completeness of any information herein, nor does Bloomberg make any warranty, express or implied, as to the results to be obtained therefrom, and, to the maximum extent allowed by law, Bloomberg shall not have any liability or responsibility for injury or damages arising in connection therewith.
Mutual fund investing involves risk; loss of principal is possible. Investments in bonds may decline in value due to rising interest rates, a real or perceived decline in credit quality of the issuer, borrower, counterparty, or collateral, adverse tax or legislative changes, court decisions, market or economic conditions. High-yield bonds are subject to greater credit risk, default risk, and liquidity risk.
Before investing in the Fund, carefully read about and consider the investment objectives, risks, charges, expenses, and other information found in the Fund’s prospectus. The prospectus is available from your financial professional, by clicking here, and by calling 800-437-1020.