Are Investment Grade Corporate Bonds the New Risk-Free Asset?

Jeffrey Buchbinder (00:00):

Hello everyone and welcome to LPL Market Signals. Jeff Buchbinder here with my friend and colleague Lawrence Gillum. Lawrence, we're going to talk stocks and bonds as we usually do when we are together. Got a little earning season preview and a discussion of corporate bonds as a potential risk-free asset. So, how are you today?

Lawrence Gillum (00:24):

I'm good. I I'm still recovering from yesterday's Bucks game. Another nailbiter to the end, but so far so good. It's, it's, it's been a fun season.

Jeffrey Buchbinder (00:35):

Yes, buck fans enjoy it. Certainly. I hope I'm enjoying being a Chiefs fan after tonight's game on Monday night. It is Monday, October 6th, 2025 as we are recording this Monday afternoon. And hey, we have another update. I think we got a shout at set, seven straight updates for the S&P 500. Here is the agenda for us. We're going to just recap the market action last week real quickly. Then turn to the bond market update with Lawrence. Of course, that's his thing. The question he has posed and tried to answer is whether investment grade corporates can be the new risk-free asset. Hopefully, Lawrence, you don't get us in trouble with compliance using terminology like that. A third is the earnings preview. That's a topic of our weekly market commentary this week. You can find that on lpl.com under the research tab, which you can always find every single week, or at least about 49 weeks a year, maybe.

Jeffrey Buchbinder (01:38):

I think we take a couple holidays off, but 49 or 50 weeks a year. And then we'll close of course with a preview of the week and our week ahead. Data calendar is pretty quiet and it might get even quieter because of the government shutdown, which probably goes through this week and into next week, we shall see. Alright, so starting with the market recap here, I'll do the stocks. And, and Lawrence, you can do bonds on the stock market side. Another solid week up 1.1% on the S&P 500, even better on the Nasdaq. Up 1.3% for the week. Russell 2000 small cap index up almost two. We've been talking about how we like the small cap index as a trade on the fed rate cuts. And maybe now you get a little seasonal lift, because October is here. I think there's really two themes that were prevalent last week.

Jeffrey Buchbinder (02:36):

One was certainly AI. We had a strong week for tech up, 2.3% on the week. We had an open AI private valuation of 500 billion for the market to digest. That is a lot of value for an AI model or AI models which put a pretty strong tailwind behind tech. But the star of the show was healthcare. And there it was all about policy. Essentially, the drug pricing controls proposed by the Trump administration and the exemptions, tariff exemptions for Pfizer to invest in the us. Got investors really excited to finally buy healthcare after the sector had struggled. It's one of the worst performers, not just this year, but in past years as well. You see here, down almost 3% over the last 12 months. Big laggard in 2025, although with that latest rally, it's, it is up almost 7% year to data. I think those were the two big drivers. But then behind all that is, of course, the market shrugging off, the government shutdown. Clearly pricing in that this thing's going to end before it does any meaningful economically damage. Also note, the international markets were really strong last week. You got a 3% gain basically in the EFA for developed international markets and an, and an almost 4% gain in the emerging market index. So, strong week for international stocks, certainly a good week for U.S. stocks as well, despite the shutdown.

Jeffrey Buchbinder (04:19):

So let's go to bonds, Lawrence, and then maybe we can share the commodity story.

Lawrence Gillum (04:25):

Yep. So last week was another decent week for the fixed income markets, aggregate bond index up about 50 basis points in a week that didn't have a lot of major economic data as well as no real treasury auctions for the market to digest. It was, it was good to see that seemingly there was a lot more buyers and sellers in the fixed income markets. That's a generally a good sign given all the concerns about treasury debts and debt levels and deficits and all that kind of stuff. So that was a positive sign last week to see some relative you know, interest in the, in the fixed income markets. Treasuries up only about 40 basis points, but IG Corp up about 60 basis points on the five-day period, up over 7% this year. We're going to look at spreads in just a second and, and kind of discuss or talk through that that title of the, the fixed income section.

Lawrence Gillum (05:16):

Can investment grade corporate credit be the new risk-free asset? But the rest of the markets worth pointing out, munis are, are again, showing some signs of life still underperforming relative to a lot of the tactical markets. But over the past three months, you have a positive 3% tr 3% return out of the muni bond index. It has firmly become up above the, the negative line, which it had been sitting there for, for most of the years. So that's, it's good to see the the muni markets participating as well. Outside of that plus sectors high yield bonds only up about 20 basis points. Preferreds only up about 20 basis points, EMD up about 20 basis points on the week last week. So altogether a pretty good week for fixed income markets with the core sectors, the higher quality sectors outperforming some of the lower quality sectors in the fixed income markets.

Jeffrey Buchbinder (06:08):

And I always look at the year to date number for the Bloomberg gag, the broad bond market index up 6.4%. That is a pretty solid year, certainly for bonds, and the year's not over, so could have a great year for stocks and bonds. Look at the commodities real quick. And the oil was down about three point half percent last week. That was a drag on the energy sector, certainly one of the worst performers last week. But the gold rally gold didn't get the memo. The commodities are supposed to be down because gold just keeps going higher. Look at this 18% higher in the last three months, and almost 3% last week. I'm sure a lot of folks out there have $4,000 targets on gold. We're not that far away, less than a hundred bucks. Gold continues to benefit from a rate cutting cycle globally.

Jeffrey Buchbinder (06:58):

Geopolitical risk is elevated, and at least in the us you've had generally a downward trending weaker dollar. So all those things positive for gold. Oh, and by the way, lower rates, I know I'm talking about your world, Lawrence, but lower interest rates tend to be good for gold as well. And the central banks continue to buy. So that continues to be a metal that we like, although generally speaking, we still think equities should, should be able to generate higher returns and commodities. So then turn to currencies. The dollar was up last week, so the gains in international markets were not currency driven. They were pure. So that I think is, is worth noting. International continues to lead certainly the U.S. on the currency balance, but last week got a little bit of a gain ahead of the U.S. in in local currency.

Jeffrey Buchbinder (07:56):

By the way, the Yen's making a lot of news today on the surprise election result. So it looks like we're going to get maybe a little bit more, you know, Abe three arrows than the market expected. A little more ishness than the market expected. And that is putting some downward pressure on the end today. So that would be something to watch in addition to the France political tension or uncertainty, which we will say for another day. So let's get back to you Lawrence, in the bond market update and this question that hopefully our lawyers are good with, can investment grade corporate bonds be the new risk-free asset? So you've recently published a piece on this question. First slide, not much happening in rates. Yeah,

Lawrence Gillum (08:48):

So this first slide just is a recap of what happened in the rate market last week. And as, as mentioned there not, there wasn't a lot of economic data, no treasuries to digest, so rates didn't really do much here in the us. We did see a little bit of steepening on the, in the curve. So the 30 year tenor was up about four and a half basis points, whereas the kind of the two year tenor was down by three and a half basis points. So we continued to see the curve steepening which is I think, the expectation, you know, throughout the rest of this year to see something along these lines as well to continue to see steepening in, in the, in the curve. You mentioned France and Japan. We are seeing upward pressure on long end rates here in the U.S. because of what's going on in Japan and France.

Lawrence Gillum (09:35):

Today we are up about, you know, four or five basis points on the long end of the curves because of that political dysfunction, which apparently we do not have a majority of in, in the us We don't we we're not, it is not just here in the us. There's other other countries out there that are dealing with their own issues. France is, is a, a big one but with Japan, the call it a I don't want to say call it an upset victory, but it was, it was maybe one that markets weren't really prepared for as per the, the, the price action out of the rates market. With Japan, the 30 year tenor for Japanese government bond deals is up about 14 basis points today. So they are certainly pricing in a lot more fiscal stimulus, lower or easier monetary policy, et cetera, after this election.

Lawrence Gillum (10:24):

So that has hurt the, the fixed income markets here in the U.S. as well. So given all the political dysfunction in the world and all the debt and deficit spending that's taking place within the developed markets there was a question recently posed by the Wall Street Journal. In fact is, can investment grade corporate bonds be the new risk free asset given all of what we just talked about with the, you know, the, the political dis political dysfunction and debt and deficit spending? And so if we go to the next slide that's, I, I do try to answer that in my newest publication piece. The rate and credit view LPL l advisors go to the resource center and you can search for rate and credit view if you want to read more about this. But this first chart is just looking at spreads.

Lawrence Gillum (11:11):

So spreads to treasuries are still around secular tights. This just looks at the difference between corporate bonds yields and treasury bond yields generally and come up with a spread to treasuries right now at around, call it 72 basis points. It's amongst the tightest, it's been in quite some time and as low as they've been since around 1998. And importantly, if you think markets are, are right or are, you know, if you believe in the wisdom of crowds given current pricing markets would suggest that there's not a lot of risk within the investment grade corporate bond market because spreads are as tight as they are. So it's an interesting question. You know, certainly I don't, or we don't agree with it, but markets perhaps are suggesting that investment grade corporate bonds are generally risk free. Now, the next slide is one of the reasons why we're seeing spreads as low as they are is because we have a tremendous amount of buyers buying yields regardless of what's happening in the spread market.

Lawrence Gillum (12:16):

So this is pension funding levels. So this is looking at a hundred, the hundred largest pensions in the, in the U.S. and their funding levels. When you have a funding level above a hundred percent, that means your, your pensions are fully funded, your assets are above your liabilities. So you don't need to take on as much risk. And we're seeing a lot of interest in the fixed income markets because of these pension pension investors that are buying bonds, holding to maturity regardless of the, the current spread environment. And that's helping push spreads down below to what they should be given current economic conditions. We're also seeing a lot of interest out of the the, the, the non-U.S. market as well. A lot of foreign buyers are buying a lot of investment grade corporate bonds this year as well. Once again, just buying total yields and not necessarily concerned about spreads. So, you know, in the piece I try to make the argument that despite what markets are, are pricing in spreads are way too tight given the underlying economic conditions because of all these yield buyers out there that continue to buy bonds and and hold to maturity.

Jeffrey Buchbinder (13:28):

Yeah. And they're probably a little bit nervous about treasuries given our deficit situation. So, I mean, in fact, you have some AAA ratings, right? Lawrence on the credit corporate credit side,

Lawrence Gillum (13:38):

There are, right? So there are, it's interesting, there are two companies left that are AAA rated on the investment grade corporate side. Can you guess them?

Jeffrey Buchbinder (13:48):

I think Microsoft and JNJ, is that right? That's

Lawrence Gillum (13:50):

Right. So Microsoft and JNJ Apple is double.

Jeffrey Buchbinder (13:53):

About that from the equity guy? I know pulling that out of his, out of his hat.

Lawrence Gillum (13:57):

So Apple, everyone says Apple, but Apple's double eight plus there's a lot of market pricing out there that suggests that, you know, there's a handful of companies that could be, you know, in fact risk free. The argument that, and the way I would push back on that is, you know, again, the, the exuberance for all in yields is, is distorting market pricing. And we haven't had a negative kind of credit event in a while. So I think once the, or if the economy slows or, or even contracts a little bit, you can see some spread widening, particularly in these, these companies that have negative spreads or so, you know, it, it's, it's one of those things where we, we talk about it internally. It's like, you know, picking up nickels and dimes in front of a steamroll.

Lawrence Gillum (14:44):

You don't know when that steamroll is going to come. But there's always that risk out there. Now, the question we get is how tight are spreads relative to economic conditions? And this is the next slide. So this is just our LPL research spread model. This takes into consideration financial conditions, the interest rate environment, and some fundamental economic data. The line here on this chart is the difference between actual spreads and our forecast spreads based upon our model. So the difference between those, those two inputs you do are you are starting to see a pretty big divergence between what underlying condition economic conditions would suggest these these markets should trade at versus what they are trading at. And right now the, the investment grade corporate spread based upon our model is about 34 basis points too low. So you should have a spread to treasuries around 1% or, or even higher than where they are currently. But we are getting that distortion just because of all the, the all-in yield buyers. So I guess the takeaway is despite markets pricing in, you know, the, the prospects of a risk-free asset for, with investment grade corporate bonds our view is that spreads are way too tight given these economic conditions. And it wouldn't, it wouldn't be surprising to see spread widen you know, if and when something happens within the economy.

Jeffrey Buchbinder (16:15):

So, Lawrence.

Jeffrey Buchbinder (16:16):

Based on significant widening and not widening increases in delinquencies or anything fundamental, right? This is really just saying that based on history, based on what the environment looks like, now, here's where spreads should be. That's

Lawrence Gillum (16:37):

Right. So if you look at the interest rate environment now, and you compare it to history, if you look at the, kind of the financial conditions now compared to history and if you look at kind of some of the, the fundamental data that we look at for, for this model compared to history, you add all that up together and spreads should be about 34 basis points higher than they are currently.

Jeffrey Buchbinder (16:57):

Okay? But just to be clear, we haven't really seen much of deterioration in companies' ability to pay.

Lawrence Gillum (17:03):

Not at all. Not at all. Not at all. And so, yeah, I mean, and, and, and keeping and, and taking into, into consideration as well that a 1% spread over treasuries is kind of, you know, a, a a decent spread to treasuries relative to history. So you know, we're at 72 basis points now, which is the, the tightest we've been since 1998 suggesting that, you know, markets have priced out or, or, or hasn't, haven't really priced in a lot of other risks out there despite the fact that there are some risks out there with the interest rate environment and elevated inflation and all that kind of stuff. So bottom line is investment grade corporate is way too expensive we think to have any sort of meaningful exposure to, in our, in

Jeffrey Buchbinder (17:48):

Our portfolios. Yeah, we, I know we're, we continue to be a little bit cautious on, on corporate credit and certainly aren't doing what the market's doing and, you know, paying a steep price for it. I guess you could say that stocks and bonds are actually trading like 1998 <laugh>, right? You just made that comparison. I think a lot of people are comparing this ai boom to the.com boom in 1998, 1999. There are key differences that actually is probably a good topic for a future podcast, but I'll leave it there. But just know spreads were very tight and certainly there was a lot of capital investment going on there, as we all know from history. So thanks for that, Lawrence. Let's do a quick earnings preview here, which is again, taken from the weekly market commentary on lpl.com. So I titled this Expect little Suspense because based on the economic environment, we really didn't have an inflection point of any kind economically in Q3, you know, steady economic growth, continued surge in AI spending and a week dollar, those factors alone should get us to double digit earnings growth in Q3.

Jeffrey Buchbinder (19:09):

So consensus is 8%. We think we can get something in the low teens if the historical pattern holds of companies beating estimates by somewhere in the range of five to 8%. Now, last quarter of the beat was closer to 8% because you had a lot of analysts too low because of the Liberation Day tariff event. You know, once companies reported Q2 analysts were able to get kind of back on sides, get to a more realistic place for tariff expectations. Now they're there, they're in a pretty reasonable spot. There's not going to be another sort of tariff earnings adjuster, right? So look for something in the neighborhood, maybe five to 7% upside to that 8% consensus estimate. That's a very, very strong number. And you can see here that could potentially be the start of a string of double digit earnings increases.

Jeffrey Buchbinder (20:09):

We got two last, or actually we're at three in a row now. If we get one this quarter decent shot, we get one in Q4 and then onto 2026. So the potentially market is buying ahead of that. The the mag seven are going to continue to be a massive driver. You can see here that those companies are expected to grow earnings 14%. That's consensus. So if they get the five to 7% upside, you're already about 20. And they actually, their record's been bigger upside surprises. So, you know, you could see something even north of 20%. And these companies are so big that that's going to be a huge driver. In fact, of the eight points that the S&P 500 EPS is expected to increase in the quarter, 70% of it is mag seven. It's like five and a half points almost six points out of the eight.

Jeffrey Buchbinder (21:10):

That is a massive driver. And we know that spending is coming. Not only is it coming this year, it's coming next year too. So that's going to be a continuation. Another, I don't know, six quarters at least. We think of Mag7 being a strong driver or just AI CapEx in general. Being a strong driver, we're probably going to get about 400 billion of CapEx this year on ai and could get close to 500 billion next year. These are just really big numbers that put a strong floor under S&P 500 profits. My margins are probably going to keep going up. This is really amazing because tariffs were supposed to be a drag. Now they are a drag, but they're just being drowned out by productivity increases and AI revenue dropping to the bottom line. Companies have done a great job of managing the tariffs.

Jeffrey Buchbinder (22:05):

The tariffs aren't as bad as we had thought or feared. You have exemptions, you have substitution of products, you have companies moving supply chains to avoid them. A whole number of things. So remember back in April we thought we might get 20% plus for an overall national tariff rate. Now it's looking like 13 to 14 is where we're going to land. We'll see, there's still uncertainty there, but companies can manage that amount of tariffs pretty well. And with everything else supporting earnings, you're going to have we think a, a steady increase in margins over the next several quarters. So, very good margin picture. The estimates have been trending up. This is another reason to expect above expectations for Q3 because estimate trends are positive. I think it's actually worth noting that 2026 earnings estimates have been rising just in the last few months.

Jeffrey Buchbinder (23:02):

That is rare. It's possible it won't continue in Q3 earnings season, but for now we're going to treat that as a positive signal. So while we have been talking about $280 in earnings next year, or maybe 285 based on these estimate trends and based on the macro environment, and by the way, you have stimulus in 2026 from the one big beautiful bill act, and you also have a massive amount of buybacks that are coming through and probably will continue that boost EPS, there's a realistic possibility that earnings grow 10% next year. And that puts us around two 90. So maybe we have to start thinking about 285 to 290 is our earnings range, not 280 to 285. We haven't formally changed our estimates but certainly we have a bias to raise those. So, good earnings season expected, probably no big surprises. Estimates rising.

Jeffrey Buchbinder (24:02):

Probably suggests that guidance will be pretty good. We'll see, not always, but usually. And we think more earnings, good earnings ahead. So again, Weekly Market Commentary, earnings preview. It starts at the end of this week with Pepsi and who's the other company that reports, I think Constellation Brands, Pepsi and Delta Airlines are the three that have September quarters that report this week. But next week's the banks. So really next week's when it really gets rolling. But you'll get a little bit of a a, a taste this week and I think is the market focuses on earnings and not the shutdown. That should be good for the market environment at least. Let's hope so. Not that the market needs much help because we just keep going up <laugh>, it'll stop at some point. Alright, week ahead Lawrence. Here's where I'm going to bring you back in a quiet week of data and it might get quieter because we might not get jobless claims. Didn't get jobless claims last week. We didn't get a job report last week because of the shutdown, but we will get some data. And Fed minutes is one such thing we'll get.

Lawrence Gillum (25:14):

Yeah, so it is you know, challenging to kind of come up with a mosaic if you're just looking at government data. I know that our Chief economist Jeff Roach has, has talked about using alternative data to come up with any, any sort of economic forecast. But yeah, the, the absence of government data is making things a little bit harder for the Fed. So we will hear from the Fed this week. I think there's a lot of fed speak this week along with the FOM team meeting minutes that's, that'll be released on Wednesday 20 Fed speaking engagements. I think I, I saw that that are scheduled for this week.

Jeffrey Buchbinder (25:56):

Powell's on the docket.

Lawrence Gillum (25:58):

Powell is on the docket as well. So you have no economic data, but a whole lot of fed speak. So we'll have to see how that translates into to market volatility. The other thing you have highlighted here is, is the University of Michigan sentiment. That's, this is the preliminary one. This tends to be revised going forward but it has at times moved markets. So we'll have to see how that, that plays out. And the only other thing that's not on your list here is there are some treasury auctions this week. So despite the government shutdown, treasury still operates as, as per usual. There's a, a three year or 10-year and a 30-year auction this week. So we'll have to see how that, that 30 year auction in particular goes given just the lack of, of demand globally for a lot of these longer maturity securities. So it I always say this and I always regret saying it, but hopefully it is just a quiet week across the board for markets. But because I said that it won't be.

Jeffrey Buchbinder (26:56):

Well, we'll see you could argue that no economic data means no cell catalyst. And maybe we'll just keep drifting along the path of least resistance. It appears, at least for now is still higher. We got more AI support from the a MD announcement this morning, deal with open ai. So, you know, trade from last week continues this week. Maybe maybe we'll get something from the Fed that causes folks to get a little nervous. We'll see. Maybe something geopolitically we'll have to see. I guess I guess Trump is meeting with the Canadian Prime Minister Kearney. I think there's a meeting coming up with the Brazilian president, so we always got to keep our eye on, on those things. But yeah, for now it looks like the seas are, are pretty calm. So if we do go get unexpected October this week, Lawrence, I'll go down with the ship with you.

Jeffrey Buchbinder (27:59):

All right. Appreciate that. I'll be wrong. I'll be wrong as well. because I think it's going to be pretty calm. And by the way, there's nothing that's going to happen on the shutdown this week. The house isn't in session. It's, there's really no catalyst for a quick settlement there. We're probably going to have to wait two weeks, maybe even three weeks, which is how long the shutdown in the mid nineties and in 2013 lasted. And those are the ones that are, that people are comparing this to. So yeah, buckle up. I mean, it's obviously disappointing. We want federal employees to be paid. Some of them are getting furlough furloughed. Some of them are working without pay until this thing is resolved. It's, it's very unfortunate, but at some point the pain gets too intense and the sides will come together. I think that's why the market's shrugging it off.

Jeffrey Buchbinder (28:50):

The market knows, and I think rightly so that this thing will be over probably in a month or less. But when you start looking at what might happen in November, if this keeps going, you really, the, the amount of pain is potentially quite high in terms of economic impact. And, you know, tt SA lines for Thanksgiving, you take away the TSA lines in Thanksgiving, you do not have a political winning political strategy. And if you, at some point, we don't expect this to happen, but if at some point you delay social security checks, you have a losing political strategy, I am being sarcastic. We are not going to see social security checks not come in the mail, <laugh>, trust me on that. So at some point there are these pain points that will push the two sides to come to a deal. They're just trying to score some political points right now. We'll see how it goes. We'll keep following it, but for now probably nothing, probably nothing to it.

Lawrence Gillum (29:54):

October 29th is the next fed meeting. So if they don't have the economic data by then, that could get pretty dicey for the, for the Fed as well. So we'll see about the, the alternative data. But October 29th is the, is the next fed meeting. So

Jeffrey Buchbinder (30:07):

I think Mr. Powell might have to call Jeff Roach and ask him for his set of alternative data. He's got a lot of it. So, so yeah, let, let's hope this thing's over by October 29th. But certainly there's a very real possibility that it goes beyond a month. Trump 1.0 shut down off the top of my head, I think, what, 35 days?

Lawrence Gillum (30:31):

It sounds right.

Jeffrey Buchbinder (30:32):

So it could be longer. So buckle up. We have written a fair amount about that. The stock, that topic, the stock market tends to go up during shutdowns at least over the last 30 years modestly, but still generally stocks shrugged these off and we expect this time to be no different, although you never know what other catalyst is going to come along. So with that, we'll wrap. Thanks Lawrence for jumping on this week's market signals. Thank you to all of you for listening or watching. Really appreciate your support. We'll be back with you next week. Thanks again for joining. Take care. Have a great week everybody.