with Randy Masel, Managing Director (December 2, 2014)
November was largely a month to forget for high yield investors. While equities continued to grind higher (S&P up 2.69% on a total return basis), the high yield market faltered, losing .72% for the month. The yield to worst call for the Bank America Merrill Lynch High Yield index stood at 6.15% at the end of the month, 30 basis points wider than where it started November. This higher yield was not a function of Treasuries: the five year Treasury yield dropped 13 basis points in November, ending the month at 1.48%.
High yield’s underperformance in November can be in part attributed to the poor performance of mining and energy securities over the course of the month and their disproportionate weighting in high yield. The energy sector comprises roughly 15% of the high yield market but only a little over 8% of the S&P. OPEC’s Thanksgiving Day decision to keep production constant has further pressured oil prices and consequently high yield energy bonds. Selling has been somewhat indiscriminate; even some high quality BB energy bonds have experienced 10-15 point price drops since the end of October. E&P companies that have hedged a significant portion of 2015-2016 production have also been taken to the wood shed. It is as if the market has assumed that oil prices will stay at these five year lows forever.
The impact of lower oil prices is not all bad for high yield, however. Certain sectors will benefit- airlines and chemical companies with oil-based feedstock, for example. Moreover, lower oil prices are likely to dampen inflationary pressures, which could push out the timing of the first Fed rate hike. In fact, Fed futures now indicate that the first Fed rate hike will most probably occur in October 2015, one month later than indicated at the beginning of November.
It is becoming increasingly obvious that the more immediate threats to high yield are not rate related, although you would never know that by reading the newspapers. Rather, weak commodity prices have negatively impacted sizable sectors of the high yield market. At the same time, more limited market liquidity is starting to be felt in risk premiums and has created exaggerated price moves. The current environment is not conducive to trading high yield bonds. However, for patient investors that are willing to ride out bouts of occasional volatility and price swings, the current environment is providing some interesting buying opportunities.
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The opinions expressed are those of the Granite Springs Asset Management LLC Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions. Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Nothing herein should be construed as a solicitation recommendation or an offer to buy, sell or hold any securities, other investments or to adopt any investment strategy or strategies. This material is for educational purposes only. Granite Springs Asset Management LLC is an investment adviser registered with the US Securities and Exchange. Registration does not imply a certain level of skill or training. More information about Granite Springs Asset Management LLC can be found in its Form ADV which is available upon request.