Following the recent tariff announcement by the U.S. President, corporate bonds within the automotive sector may witness a rally, presenting an appealing investment opportunity according to JPMorgan Chase & Co. While the pharmaceutical industry faces significant challenges due to the tariffs, automakers might not suffer as much. With spreads on auto bonds reaching their widest since July 2020, there's potential for recovery. Additionally, bonds issued by pharmaceutical companies are less favorably positioned macroeconomically due to reliance on imported ingredients.
Potential Upside in Automotive Bonds
JPMorgan strategists argue that large automakers are unlikely to be downgraded to high yield status in the near future. Consequently, if the tariff announcements act as a clearing event, auto bonds could experience a rally. The sector currently trades at its widest spread compared to the JPMorgan US Liquid Index since mid-2020 and is the worst-performing major sector.
Given the extreme valuation disparity between auto and pharmaceutical sectors, with a spread gap of 52 basis points, auto bond spreads would need to widen another 35 basis points to erase excess returns over the next year. This scenario, while plausible, would align auto bonds with BB-rated junk bonds levels seen earlier this year. Manufacturers such as General Motors, Stellantis NV, Hyundai Motor Co., and Nissan Motor Co. are expected to bear substantial impacts depending on their exposure to light-vehicle imports.
Pharmaceutical Bonds Under Pressure
Bonds issued by pharmaceutical companies seem poorly placed given the heavy reliance on imported ingredients, particularly from countries like India, which may become focal points for reciprocal tariffs. As a result, the sector offers a viable hedging strategy amidst uncertain economic conditions.
The estimated annual impact on earnings before interest and taxes for each manufacturer ranges from $1 billion to $4.4 billion due to proposed tariffs on U.S. auto imports and those specifically targeting China. Despite these challenges, the automotive sector remains relatively robust compared to pharmaceuticals, where a significant portion of ingredients are sourced internationally, making them more vulnerable to trade disruptions. Thus, investors seeking stability amid global trade tensions might find refuge in automotive bonds rather than pharmaceutical counterparts.