High Yield

High Yield

August 10, 2020 will go down in history as the first time a high yield, or junk bond, priced at under 3%.

Ball Corporation, rated one notch below investment grade by the rating agencies, was able to issue 10-year bonds at a yield of 2.85%.  This represented a spread of merely 2.25% more than the 10-year Treasury bond.  Historically, lower high yield spreads indicate a constructive economic outlook and less risk to these credits.  The spread required by investors to own high yield bonds relative to Treasury securities has declined more than 6% since March, this during a time when unemployment remains in double digits and GDP is negative. Helping to shrink this spread are the myriad government programs meant to help companies directly via lending and indirectly via purchases of existing corporate bonds.

Mission accomplished!!

High Yield

What we find particularly interesting is the juxtaposition between the level of these spreads and the perceived level of losses in the real economy as recorded by banks over the past several quarters.  Due to new regulations, banks are required to recognize losses in advance of incurring them based on economic models.  To say this pandemic has stretched those models would be an understatement.  Unemployment went from 4% to 15% in a month, and GDP for 2Q was -32%.  As a result, banks have recognized potential credit losses of nearly $200B this year. 

The level of bank reserves and the resulting current stock prices indicate significant credit losses are coming.  High yield spreads are indicating corporate debt is nearly risk-free.  It would seem rather odd that the banks alone will shoulder these losses and that investors in high yield would go unscathed.   The present high yield spreads and discount to book value that financials trade at currently cannot both be correct.  The market has severely mispriced one and possibly both. 

 

As we begin to get a peek at what 2020 might have in store for investors, we continue to see some encouraging signs in the economic data.  Following a growth slowdown in the middle part of 2019 as the US-China trade war stifled businesses’…
There is an investing adage that says, “Don’t fight the Fed,” and has that adage ever proven true this cycle, but especially so in both 2018 and 2019. It’s been well documented that various rounds of so-called “Quantitative Easing” coming out of the…
On Wednesday, August 14th broad stock market indices experienced a roughly 3% drop across the board – the worst day of 2019. Stocks sold off immediately at the opening bell and continued to worsen throughout the day. The reason: a growing sense of…
Just nine to twelve short months ago, interest rates were steadily climbing off the mat toward 3% and the path forward was on cruise control.  The primary debate among informed market observers seemed to focus on whether 2019 would see three or four…
After sprinting to a 25% advance from the late December 2018 lows to a new high of 2945 on the S&P in early May, led again by the tech/growth complex, the market faded by ~5% in May.  The culprit was a rapid escalation in trade tensions…
What a wild few months it’s been.  Long gone are the calm, smooth waters of 2017.  2018 ended with a bang – or a crash!   The dip in October as more rate hikes were foreshadowed was followed by a midterm election induced rally in November.  Then the…