High yield market may offer buying opportunity
The setback for the high yield market in August may have created a buying opportunity, according to Johan Jooste, head of strategy for fixed income in Merrill Lynch Wealth Management’s EMEA chief investment office.
“There are some very good fundamentals supporting the market. BofA Merrill Lynch research refers to the situation as a “goldilocks” for credit: where growth is tepid enough to make life difficult for equity investors, but strong enough to enable the majority of bond issuers to make interest payments without strain,” said Jooste in his latest credit update.
Excluding the past four weeks, funding in the high yield area is still characterised by good demand for new issuance. The low level of defaults is also supportive of the market and with default rates expected to rise to only 3% to 4% of issuers, there is ample spread in the market to compensate for possible losses, the note said.
“The reaction of the high yield market underscores the view that the current episode is more akin to what had become the norm pre-2008, as opposed to a re-run of 2008. Spreads in the high grade market have been extremely well-behaved compared to 2008, with the notable exception of the financial sector. From this we may be tempted to infer that the generalised view of credit defaults across the market is still quite benign – it is not a quirk of the pricing currently observed in high yield,” said Jooste.
Nevertheless it is important to remain cautious about market developments. The fact that credit has held up reasonably well so far is no guarantee that it will continue to do so if markets remain volatile. Also, a deeper recession than anticipated would drive default rates higher and erode much of the benefits of higher coupon interest income.
Since the crisis in 2008, the general view has been that high yield will display equity-like volatility if the market comes under renewed pressure. It is not necessarily wise to jettison this assumption on the evidence of six weeks or so, said Jooste. The best view on high yield is perhaps to hold fire until it is clearer that the fog has lifted.
“However, it should be viewed as merely a matter of time to enter [the market], unless the view on the economy becomes one of outright and prolonged recession,” Jooste said.