Lesson: Low Spreads for High-Quality Bonds in Crises

Diving into the history of Morgan Stanley’s first bond deal, our Head of Corporate Credit Research Andrew Sheets explains the value of high-quality corporate bonds.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. 

Today, a look at the first bond that Morgan Stanley helped issue 90 years ago and what it might tell us about market uncertainty. 

It's Thursday, October 9th at 4pm in London. 

In times of uncertainty, it's common to turn to history. And this we think also applies to financial markets. The Great Depression began roughly 95 years ago. Of its many causes, one was that the same banks that were shepherding customer deposits were also involved in much riskier and more volatile financial market activity. 

And so, when the stock market crashed, falling over 40 percent in 1929, and ultimately 86 percent from a peak to a trough in 1932, unsuspecting depositors often found their banks overwhelmed by this market maelstrom. 

The Roosevelt administration took office in March of 1933 and set about trying to pick up the pieces. Many core aspects that we associate with modern financial life from FDIC insurance to social security to the somewhat unique American 30-year mortgage rose directly out of policies from this administration and the financial ashes of this period. 

There was also quite understandably, a desire to make banking safer. And so the Glass Steagall Act mandated that banks had a choice. They could either do the traditional deposit taking and lending, or they could be active in financial market trading and underwriting. In response to these new separations, Morgan Stanley was founded 90 years ago in 1935 to do the latter. 

It was a very uncertain time. The U.S. economy was starting to recover under President Roosevelt's New Deal policies, but unemployment was still over 17 percent. Europe's economy was struggling, and the start of the Second World War would be only four years away. The S&P Composite Equity Index, which currently sits at a level of around 6,700, was at 12. 

It was into this world that Morgan Stanley brought its first bond deal, a 30-year corporate bond for a AA rated U.S. utility. And so, listeners, what do you think that that sort of bond yielded all those years ago? 

Luckily for us, the good people at the Federal Reserve Bank of St. Louis digitized a vast array of old financial newspapers. And so, we can see what the original bond yielded in the announcement. The first bond, Morgan Stanley helped issue with a 30-year maturity and a AA rating had a yield of just 3.55 percent. That was just 70 basis points over what a comparable U.S. treasury bond offered at the time. 

Anniversaries are nice to celebrate, but we think this example has some lessons for the modern day. Above anything, it's a clear data point that even in very uncertain economic times, high quality corporate bonds can trade at very low spreads – much lower than one might intuitively expect. 

Indeed, the extra spread over government bonds that investors required for a 30-year AA rated utility bond 90 years ago, in the immediate aftermath of the Great Depression is almost exactly the same as today. 

It's one more reason why we think we have to be quite judicious about turning too negative on corporate credit too early, even if the headline spreads look low. 

Thank you as always for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also, please tell a friend or colleague about us today.