High-Yield Corporate Bonds: The Rally that Lacks Conviction
Not all prices in a strong first half were lifted equally by this Fed-induced rally.
Several themes emerged in the first half of 2019. Chief among them was the desire to extend duration as Treasury yields fell across the curve with the market pricing in Fed easing over the next 18 months. Since peaking above 3 percent in 2018, five-year and 10-year Treasury yields have fallen to near 1.8 percent and 2.0 percent, respectively, as of late July. But not all of the performance was rate-driven in high-yield corporates, since spreads have compressed meaningfully since the beginning of the year. Other features of this rally included a preference for liquidity offered by large capital structures. BB and B bonds in issues of larger than $1 billion delivered excess returns over Treasurys of 6.8 percent and 7.0 percent, respectively, compared to excess returns of 5.5 percent and 5.1 percent for BB and B bonds sized between $250 million and $500 million.
Total return through the first half of 2019 for the ICE BofA Merrill Lynch High-Yield Constrained index was 10.2 percent, with excess return over Treasurys representing 5.9 percent of that. The increased attractiveness of high-yield corporates due to their fixed-rate nature gave the market a meaningful boost in performance over similarly rated floating-rate sectors. For example, BB corporates have outperformed BB loans by 4 percentage points year to date through July 24, and they outperformed BB CLOs by 3 percentage points.
High-Yield Corporates Outperformed Similarly Rated Floating Rate Sectors
BB corporates have outperformed BB loans by 4 percentage points year to date through July 24, and they have outperformed BB CLOs by 3 percentage points.
Source: Guggenheim Investments, ICE BofA Merrill Lynch, JP Morgan, Credit Suisse. Data as of 7.24.2019.
In the first quarter, we noted some signs that this rally lacks conviction, which continued through the second quarter. CCCs are lagging in performance, with the category’s excess returns over Treasurys at 4.5 percent year to date, compared to 6.8 percent in BBs and 6.0 percent in single-Bs. Since the beginning of June, when the Fed sent clearer signals about a possible rate cut in July, CCC excess returns have been largely flat while BBs and Bs earned positive returns over Treasurys. We forecast that the 12-month trailing par-weighted default rate will climb to about 3 percent by year end, up from less than 1 percent currently, and will ease in early 2020. But the gap in excess return between higher beta CCCs and lower beta BBs points to brewing market concerns over credit risk. Even as the Fed's stance has become more accommodative, this rally is more driven by liquidity than fundamentals and may leave the riskiest borrowers exposed.
CCC Excess Return Divergence from BB and B Signals Credit Concerns
Since the beginning of June when the Fed sent clearer signals about a possible rate cut in July, CCC excess returns over Treasurys have been largely flat while BBs and Bs earned positive returns over Treasurys.
Source: Guggenheim Investments, ICE BofA Merrill Lynch. Data as of 7.24.2019.
—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, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.
©2019, 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.
Portfolio Manager Adam Bloch and Matt Bush, a Director in the Macroeconomic and Investment Research Group, share insights from the third quarter 2019 Fixed-Income Outlook.
Anne Walsh, Chief Investment Officer for Fixed Income, shares insights on the fixed-income market and explains the Guggenheim approach to solving the Core Conundrum.
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"). Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
Read a prospectus and summary prospectus (if available) carefully before investing. It contains the investment objective, risks charges, expenses and the other information, which should be considered carefully before investing. To obtain a prospectus and summary prospectus (if available) click here or call 800.820.0888.
Investing involves risk, including the possible loss of principal.
*Assets under management is as of 6.30.2019 and includes leverage of $11.2bn. 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, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
Guggenheim Investments. All rights reserved.
Research our firm with FINRA Broker Check.
• Not FDIC Insured • No Bank Guarantee • May Lose Value
This website is directed to and intended for use by citizens or residents of the United States of America only. The material provided on this website is not intended as a recommendation or as investment advice of any kind, including in connection with rollovers, transfers, and distributions. Such material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. All content has been provided for informational or educational purposes only and is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation. Investing involves risk, including the possible loss of principal.