More the Way it is Supposed to Work
by Randy Masel, Managing Director (February 4, 2015)
The high yield market returned to normalcy in January. Prices moved up a smidge and, with coupon income, returns for the Bank of America Merrill Lynch High Yield II Master Index totaled .69% for the month. To be fair, the credit market had the wind at its back in January given the huge rally in Treasury bonds; the five year Treasury alone rallied almost 2 ½ points over the course of the month. High yield returns, though positive, did not keep up with Treasuries. While yields dropped 20 basis points to 6.45%, spreads widened 21 basis points to +534. This underperformance is largely attributable to the poor performance of the energy sector as oil prices continued their nosedive. Total return in the energy subsector was -.65% for the month. Investment grade corporate bonds, by comparison, benefitted from their longer duration and smaller energy weighting. The Bank of America Merrill Lynch US Corporate Index was up 2.74% for the month. Equities, which suffered jitters over earnings, valuations, and Greece, fared much worse in January; total return for the S&P index was -3%.
While some media stories and analysts are still trying to spook investors about the dangers of high yield, the market feels a bit “Goldilockish” to me- not too hot, not too cold. Investors are not blindly chasing new issues and are more discerning in their approach to risk. At the same time, funds flows have turned positive and there is ample demand for well-priced, solid credits. Case in point: $2.4 of Altice bonds were priced on the last business day of the month and promptly traded up two points.
Although I am very reticent to say it, oil prices may have hit a bottom. That being said, oil prices will need to move significantly higher from here over the next two years in order to avoid financial stress for many high yield energy companies. Given minimal near-term maturities, existing liquidity, and price hedges, bankruptcies over the very near term should not be significant. The silver lining for investors is that prices of high yield energy bonds, with price drops of 30-70 points, have adjusted and more accurately reflect the prospects of bankruptcies and financial distress. This puts high yield on more solid footing to post more months like January going forward.
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.