High Yield Index Masks Significant Credit Dispersion

November 26, 2015

High Yield Index Masks Significant Credit Dispersion Photo

The high yield market is tracking toward a low, single-digit negative total return for the year. This would only be the fifth time in the last 30 years that the high yield market has posted negative total returns, and only the second time that was not associated with a recession (1994 being the other). Of course, the fact that the J.P. Morgan Domestic High Yield Index (JPMHYI) may be in negative territory for a calendar year is rare, but not necessarily remarkable. Also, related performance is tracking reasonably close to most other major equity and fixed income markets this year, such that the magnitude of the decline doesn’t stand out either. What does stand out is the tremendous bifurcation in the market from both a sector and credit-quality perspective.

With regard to ratings, BB-rated credits have outperformed single B- and CCC-rated credits by about 400 and 900 basis points respectively, year-to-date. Excluding commodity-related sectors, the outperformance is much less dramatic but still, perhaps, significant.

The extent of the outperformance of higher quality credits is a little surprising given the economic and capital market backdrop – moderate Gross Domestic Product (GDP) growth, an improving labor market, low inflation, and readily-available financing. Typically, this would bode well for riskier credits that need top- and bottom-line growth to deleverage. Moreover, when default rates are benign (credit risk is low) and fears that Treasury rates may rise (duration risk is high), institutional investors gravitate to yieldier credits in order to outperform. For a variety of reasons -- including weak earnings, rising leverage, and increased regulatory risk -- the opposite has occurred this year.


In terms of sectors, the metals and mining and energy industries, the latter as the largest constituent in the JPMHYI , have been massive underperformers year-to-date, declining about 13% and 23%, respectively. Also in negative territory are the chemical, broadcasting, telecommunication, and utility sectors. Meanwhile, consumer-oriented and domestically-focused industries like food and beverage, gaming, and housing are among the strongest performers, registering gains of over 5% during the year-to-date period.

Key Takeaway: Dispersion is a key facet of today’s high yield market and the modest negative returns, year-to-date, hide the volatility underlying the JPMHYI . To say it’s a credit picker’s market would be a big understatement. Companies experiencing negative headlines, earnings misses, funding needs, and/or covenant issues are being punished, and poor market liquidity is exacerbating the problem. My bias is still to fade market rallies and position conservatively as we enter the latter stages of this credit cycle.

Tags: Chart of the Week | High-Yield Bonds | Credit cycle | J.P. Morgan | Metals & Mining | Credit ratings | Sector performance

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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.

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