High yield bonds are experiencing larger price fluctuations given the low-liquidity environment and lower dealer inventories; the recent drawdown appears to be creating value in the sector.
Late-cycle behavior: The high yield market continues to show indications that we are entering the late-cycle phase of economic cycle, including weaker profit growth expectations, increasing leverage, and more shareholder-friendly activity (share repurchases, dividend increases, merger/acquisition announcements). Additionally, it appears that risk appetites have reached oversold levels and market conditions may be in place for a meaningful recovery.
Given this backdrop, we favor mid-to-upper quality credits within the high yield universe. In our view, this cycle could continue for roughly another two years.
Liquidity issues: Liquidity remains challenged, which makes reallocation trades more expensive. We expect volatility to remain elevated due to considerable uncertainty concerning Fed policy actions and investor sentiment. Market conditions since the December FOMC meeting appear less accommodative and events are moving fast. As of February 16, the S&P 500 Index® is down approximately 9%, oil prices (WTI) have declined by over 20%, and high yield spreads are over 150 basis points wider. However, in my view, these developments do not justify a change in monetary policy outlook.
Energy markets: Credit rating agencies have significantly lowered oil and gas price forecasts; this has increased downgrade risks in the high yield and investment grade sectors. In fact, Barclays is estimating that approximately 3% of the investment grade index, or $146 billion of market value, could fall into the high yield sector.
Weathering the current state of the energy markets has been problematic for certain issuers, as the anticipated decline in production levels and associated energy price impact have yet to be felt. However, we continue to believe US energy production will ultimately decline more rapidly than it has to date and that higher levels of energy prices will materialize by late 2016 and into 2017. At today’s prices, we believe there are attractive values in select energy credits.
Against the backdrop of these developments, we see opportunity for long-term investors. Liquidity is draining and high yield prices remain off from previous levels. Market dislocation has, in our view, created one of the best opportunities since 2008 to buy into well-researched high yield positions.
This is not an offer of, or a solicitation of an offer for, any investment strategy or product.
Any investment that has the possibility for profits also has the possibility of losses.
Commodity interest and derivatives trading involves substantial risk of loss.
Past performance results are not necessarily indicative of future results.
This blog post is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. This information is subject to change at any time without notice.