March 17, 2016
Commodity market weakness spilled over into the high-yield bond market in 2015. Energy and basic materials were the worst performers. Rising mutual fund redemptions exacerbated high-yield price dislocations mid-year, while later in the year the European Central Bank’s (ECB) disappointing stimulus announcement and OPEC’s unwillingness to cut oil production further contributed to spread widening.
Among the worst performing high-yield subsectors in 2015 were materials, media, telecom, and utilities, which carry the highest debt burdens based on leverage ratios (net debt/EBITDA). Subsectors that have maintained high interest coverage, as well as select creditworthy issuers in energy and materials, look attractive as we position for a rebound.
Source: BofA Merrill Lynch, Guggenheim. Data as of Q2 2015.
These macro pressures led to the high-yield bond market’s first annual loss in six years in 2015, with a total return of -4.9 percent as spreads widened by 184 basis points to 754 basis points, the most since 2011. Spreads for high-yield issues exenergy widened by 133 basis points. The selloff that began in commodities was particularly punishing for CCC-rated credits, which delivered a total return of -15.5 percent, compared to total returns of -0.36 percent and -4.6 percent for BB-rated and B-rated credits, respectively.
Concerns are mounting that the correction in prices foreshadows a new wave of defaults, which explains the market’s 600-basis-point premium over investmentgrade corporate bonds at year end, premiums last seen in 2009. Our Macroeconomic Research Team’s constructive view on the U.S. economy, combined with our review of underlying fundamentals—interest coverage, leverage, and earnings growth—indicates that this should only be a passing storm. Interest coverage is well above historical averages at 4x annual interest costs (excluding energy and metals companies), and earnings growth is moderately positive in most sectors. Excluding bonds issued by below-investment-grade, commodities-based companies, high-yield bonds offered 8 percent yields at the end of 2015, on average. Under a 2008-type default scenario, investors would still earn an attractive 6.4 percent yield on an annual basis, assuming no recoveries. This is not our base case, however; we believe that outside of commodities, the default rate will remain below the historical average of 4.5 percent in 2016. With such an attractive risk-adjusted return profile, we are seeking to taking advantage of volatility and depressed pricing to buy bonds issued by strong but undervalued companies, including select credits in media, consumer staples, and communications.
As investors grow wary of market turmoil and the potential implications for U.S. credit, highyield bonds are trading at spreads that are nearly 600 basis points over the investment-grade corporate bond market. The premium in high-yield bonds has surpassed 2011 levels and returned to premiums last seen in 2009, despite the fact that fundamentals are stronger today.
Source: Barclays, Bank of America Merrill Lynch, Guggenheim. Data as of 12.31.2015.
—Thomas Hauser, Managing Director
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment-grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating-rate senior-secured syndicated bank loans and other floating-rate securities involve special types of risks, including credit risk, interest-rate risk, liquidity risk and prepayment risk.
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