Chart of the Week

Sources: Bloomberg, Moody’s, and Wells Fargo Investment Institute. Quarterly data from January 1, 1986 to September 30, 2020. Q4 2020–Q4 2021 speculative grade default rate forecasts from Moody’s forecasts, as of September 30, 2020. The nonfinancial corporate debt data includes both High Yield (HY) and investment-grade (IG) corporate debt. GDP = gross domestic product. This chart was excerpted from Market Charts: Turning data into knowledge (Q1 2021)

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U.S. corporate debt outstanding (orange line) reached an all-time high in 2020, and issuance for both investment-grade and high-yield debt broke records. Corporate default rates (purple line) had been low by historical standards, but strain from the coronavirus-related slowdown pushed defaults higher. We expect defaults to peak in the first quarter of 2021.

While we may see some near-term volatility, an extended low-rate environment should be a long-term positive for credit-related sectors, allowing many issuers to refinance in order to extend maturities and lower interest expense.

With a low-yield environment expected to persist well into the economic recovery, we believe that investors should favor higher-yielding fixed-income asset classes and sectors. Corporate bonds should continue to pay a premium over Treasury securities; we favor high-yield and preferred securities.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. There are special risks associated with investing in preferred securities. Preferred securities are subject to interest rate and credit risks. Interest rate risk is the risk that preferred securities will decline in value because of changes in interest rates. Credit risk is the risk that an issuer will default on payments of interest and principal. Preferred securities are generally subordinated to bonds or other debt instruments in an issuer's capital structure, subjecting them to a greater risk of non-payment than more senior securities. In addition, the issue may be callable which may negatively impact the return of the security. Preferred dividends are not guaranteed and are subject to deferral or elimination.

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