High-Yield Corporate Bonds: Prone to a Near-Term Shock
Seasonal patterns suggest that we will experience more summer volatility before an end-of-year rally.
High-yield corporate bond credit metrics showed some improvement in the first quarter of 2017, the latest available data, but we are careful not to interpret one data point as a new trend. Leverage ratios and interest coverage improved, but earnings were down 0.3 percent on a year-over-year basis.
High-Yield Corporate Bond Sector Credit Metrics Improve in the First Quarter
High-yield corporate bond credit metrics appear to be improving, but we are cautious not to label this a trend reversal just yet. We are optimistic, however, that 2017 will be a year where rising leverage multiples and declining coverage ratios take a brief pause until 2018.
Source: Morgan Stanley, Guggenheim Investments. Data as of Q1 2017.
High-yield corporate bond credit metrics showed some improvement in the first quarter of 2017, the latest available data, but we are careful not to interpret one data point as a new trend. Leverage ratios and interest coverage improved, but earnings were down 0.3 percent on a year-over-year basis. Still, this is a significant improvement from steeper declines in the prior six quarters, and we take it as an encouraging sign that the deterioration we witnessed last year has at least stalled. New-issue activity is up 17 percent from the same period last year, another positive sign. Visible flows into the high-yield sector suggests investors are pulling money, however, as high-yield mutual funds have seen approximately $9 billion in outflows while high-yield exchange-traded funds are flat. These conflicting indications—tightening spreads, strong activity, but weak visible demand—make it difficult to decipher whether investors are risk-on or riskoff in high-yield bonds. We believe they are cautiously optimistic.
High-yield corporate bonds returned 2.0 percent in the second quarter. Spreads tightened by 22 basis points quarter over quarter, ending June at 428 basis points. Year-to-date performance has been strong. High-yield corporate bonds have delivered returns of 4.4 percent year-to-date through the end of the second quarter, on track to meet the expectations that we laid out at the beginning of the year.
We share the high-yield market’s cautious optimism. We expect returns will be decent, but differ by credit. Going down in quality at these spread levels fails to compensate longer-term investors for credit risk and volatility. The CCC-bond rally already started to fade in the second quarter, and seasonal patterns suggest that we will experience more summer volatility before an end-of-year rally. This tells us to stay up in quality, with a preference for BB-rated and select B-rated credits that pass our credit reviews.
CCC-Rated Bond Rally Is Beginning to Fade
After 12 consecutive months of CCC-rated corporate bonds outperforming BB-rated corporate bonds between March 2016 and February 2017, we have begun to see a reversal in this trend this year. CCC-rated bonds underperformed BB-rated bonds by 0.7 percent in April and 0.9 percent in June, making this the first quarter of relative underperformance by lower-rated bonds since the first quarter of 2016.
Source: Bloomberg Barclays, Guggenheim Investments. Data as of 6.30.2017.
—Thomas Hauser, Senior Managing Director; Rich de Wet, Director
Important Notices and Disclosures
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. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2017, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.
VIDEOS AND PODCASTS
Scott Minerd, Guggenheim Partners Global CIO and Chairman of Guggenheim Investments, joins Bloomberg TV on Fed Day.
Brian Smedley, Chief Economist and Head of the Macroeconomic and Investment Research Group, discusses the Fed’s third straight 75 basis point hike and its meaning for the economy and investors.
Guggenheim Investments. All rights reserved.
Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.