High-Yield Market Is Fairly Priced
Portfolio Manager Seth Meyer discusses the current state of the high-yield market, which he views as fairly priced, given a strong technical tailwind and constructive fundamentals. We believe investors can find attractive opportunities in B-rated bonds issued by companies with both the ability to generate free cash flow and the willingness to use it to delever their balance sheets.
- Even with the year-to-date rally, high-yield valuations appear relatively attractive.
- We believe a strong technical tailwind coupled with constructive fundamentals should continue to support high-yield valuations.
- We believe the B space is currently presenting the most attractive opportunities.
Seth Meyer: If you’re talking about what’s happened so far in 2019, you can’t forget about how painful Q4 of 2018 was. Q4, the markets as a whole, risk taking as a whole was really taking a step back and trying to really identify what the Fed was trying to achieve. Fast forward to January and that narrative changed a 180 as the Fed started to change their tune in respect to raising rates. That’s really why the market revalued as quickly as it did.
If you remove the significant sell off that we had in the month of December, and just ignore that that 31-day period ever happened, spread levels actually still look relatively attractive.
Technically, the market is starved for new issuance. So there are no new corporate bonds coming into the high-yield market. There are, but in very small amounts. As a money manager who’s getting paid a coupon, I have to reinvest that coupon into something. We are all buying fewer and fewer high-yield bonds. That is a technical picture that is very strong.
High-yield companies are still deleveraging, they’re still in the mode of fixing their balance sheets. Part of it is the mindset and access to capital. As you approach end-of-cycle behavior, we’re actually seeing very rational decisions from CFOs and treasurers of high-yield companies to continue to delever. The default rate on a trailing 12-month level was actually at an all-time low. Corporations are still growing, albeit slower than they were a year ago. So from a fundamental perspective, we’re actually still positive [on] what we’re seeing in the U.S. Coupling the technical with the fundamental, I feel right now is actually relatively fair value for high yield.
We think right now that investors can find total return opportunities in the B space. BBs, which are the most interest rate sensitive, have really run and rates are very low right now. So you do have some interest rate risk if rates were to go higher. CCCs, on the surface, aren’t as cheap as they appear. There are a few very large capital structures that are driving that CCC spread wider. So right now, we’re finding some good B names in the space that we think have the free cash flow, not only free-cash-flow generative ability, but also management team’s willingness to delever their balance sheets.
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Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
High-yield or “junk” bonds involve a greater risk of default and price volatility and can experience sudden and sharp price swings.
Credit Spread is the difference in yield between securities with similar maturity but different credit quality.
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