The daily record highs in the equity markets and the relentless grind tighter in the credit markets elicit both feelings of marvel and trepidation. As you can see in the chart above, revenue and EBITDA are growing at strong levels across the companies in the S&P 500. The uneasy feeling in the fixed income market comes from the disparity between valuations at or near their post crisis tights versus the constant barrage of negative news outside of Wall Street – North Korean war talk, devastating hurricanes and fires, mass shooting in Las Vegas, and dysfunction in Washington. For most high-yield investors, waiting for the big pullback by sitting in cash is not an option, as the active manager gets compensated to take risk and outperform an index. It’s easy to get distracted in this type of market. When I sift through all the noise, I have found the best way to construct a credit portfolio is to rely on business fundamentals as a guiding light.
Fundamentals at both the macro and micro level remain largely favorable. Moreover, it feels like an inflection point might have been reached recently whereby the last vestiges of the financial crisis are being shed globally. Central bank quantitative easing is gradually being removed while global growth is accelerating. Cyclical conditions tend to be reinforcing themselves, and GDP, employment, wage growth and the ISM are on an upward trajectory domestically. At the corporate level, organic revenue, operating margins, and free cash flow are also growing at an accelerating rate, and a corporate-friendly tax bill would further accelerate earnings.
Key TakeawayWith this backdrop, it’s hard not to chase risk and drift into lower quality credit as spreads on decent fundamental stories look fully valued. Still, my bias is to stick largely with the stronger fundamental credits. This doesn’t necessarily mean higher rated securities. Rather, I am looking for securities that are deleveraging, will benefit from identifiable catalysts, have bondholder-friendly management teams, or have ratings momentum. While a lot of good news is priced into credits with the profile just described, I am confident this strategy, coupled with a hedging program that keeps portfolio duration neutral, has long-term staying power.
The material provided here 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 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.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
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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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