The picture for the high-yield corporate bond market is mixed. Performance has been strong year to date, driven by attractive yields and the lack of new issuance. Meanwhile, defaults have increased. In the first half of 2023, 11.1 percent of bonds in the ICE BofA High Yield index were downgraded versus 9.7 percent upgraded, resulting in a negative net migration rate. We remain concerned about the effects of restrictive monetary policy and slowing corporate earnings growth, which suggest that more defaults and credit rating downgrades lie ahead.
The ICE BofA High Yield Index has returned over 6 percent year to date through the end of July, with strong performance across most industries. Yet defaults have increased as some companies wrestle with increasing interest expense and unsustainable leverage ratios. The high-yield corporate bond default rate increased from 1.5 percent to 2.4 percent, according to BofA Research, which remains below the historical average of 3.8 percent. Our forecast puts the 2023 default rate at 3.5 percent and 2024 at 5 percent—a benign cycle compared to history.
Most defaults over the last 12 months came from healthcare, followed by media companies and then telecom and technology companies. We continue to view this default cycle as one driven by idiosyncratic, credit-specific factors rather than industry-specific ones, in contrast to the last several cycles dating back to the 1990s. Many defaults today have been well-known stress situations that were priced with elevated spreads for over a year, thus the lack of a surprise element is avoiding meaningful spillovers.
Despite rising defaults, high-yield corporate bond spreads are 384 basis points over maturity-matched Treasurys, which is tighter than the decade average of 446 basis points and in the 34th percentile over this period. But yields stand at 8.4 percent, which is in the 88th percentile over the same timeframe.
We believe high-yield bond spreads have limited room to tighten further, but current yields continue to appeal to investors, despite more cautious market sentiment surrounding the hardest-hit sectors. This element, combined with limited net new issuance, should keep spreads rangebound in the near term. We remain cautious in our credit selection though, focusing on issuer and industry diversification as well as moving up in the capital stack and looking for higher quality debt, given the broad-based nature of the current default cycle that is still in its early stages.
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This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.
Investing involves risk, including the possible loss of principal. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-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 and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.
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