Releveraging of Corporate America Raises Concerns | American Funds

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Midyear Outlook

Sustainable Income | bonds | july 2015
Releveraging of Corporate America Raises Concerns

Corporate Bonds Have Delivered Strong Returns, but Keep an Eye on Rising Debt Levels

Record-High Levels of Corporate Borrowing Raise Questions About the Health of Company Balance Sheets

Chart shows corporate borrowing from 1996 through 2014

Source: Thomson Reuters, SIFMA. As of December 31, 2014

Investment-grade corporate bonds overall remain at fair value, especially after a sharp correction in the energy sector. However, increasing leverage, resurgent mergers and acquisitions activity and the possibility of rising interest rates are all reasons for investors to be cautious and selective.

Mortgage-backed securities continue to trade at relatively tight spreads as the market loses one of its largest buyers, the Federal Reserve. Valuations are lofty for high-quality mortgage bonds, but they do offer slightly higher yields than Treasuries and they tend to hold up better in a rising-rate environment due to declining mortgage prepayment activity.

U.S. high-yield bonds have followed a similar pattern to investment-grade debt. But high-yield spreads are at valuation levels that make them somewhat more compelling as they widened significantly in the last six months of 2014, primarily due to trends in the energy sector.

As interest rates fell to record lows, corporate borrowing climbed to record highs. Much of the new debt has been issued to finance acquisitions, share buybacks and dividend payments. Investors should keep an eye on rising corporate debt levels, particularly when they are associated with large-scale M&A activity.

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