High Yield On Sale

Just in time for the holidays, the high yield market is holding a sale–lower prices.  Actually this market has been cheap for several weeks, but now that the stock and oil markets seem to be steadying, it is a good time to assess relative values.

In the past month, the yield on the 10-year Treasury has dropped 30 basis points.  Since mid-October, the yield on the BofAML high yield market index has increased from 6.25% to 7.40%.  The spread between the high yield and Treasury index yields, which is commonly used as the measure of value in high yield, has increased from a low of 320 basis points to around 450 bps now.  I have used a spread of 350 to 450 bps as the range that is typical for periods of relatively low default rates.  By this measure, the high yield market is now very attractive.

Investment grade spreads have also increased to attractive levels.  Typical A rated 10-year corporates now yield around 100 bps more than Treasuries.  That is at the top of the typical range of 75-100 bps.  But the high yield spreads are more compelling.

The stock market swoon, the drop in oil prices and concerns that the economy might be weakening are given as reasons for the poor performance by high yield.  The easiest to dismiss is the argument that the economy might be weakening.  Nothing in such key data series as the ISM indices, employment growth, new orders, auto sales, consumer confidence and income growth suggests an economy that is in a cyclical slowdown.  The stock market might now be recognizing this, after having gone through a serious correction.

I should not comment on oil prices, as that is a market I have never truly understood.  If, however, those prices have touched or are close to the lows for this correction, one could argue that default fears are peaking.  Managers of well diversified portfolios, supported by good credit research, would be expected to have performed somewhat better than the market indices these past two months.  Starting at current valuations, those portfolios should, in my opinion, solidly outperform Treasury and investment grade portfolios in the months ahead.

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