Areas of high yield appear cheap to SWIP’s Steve Logan
Quality areas of the high yield market appear fundamentally cheap, says Steve Logan, head of European high yield at SWIP.
Over the three decades that preceded the financial crisis, debt levels across the Western world exploded.
Today, consumers, banks and even sovereign borrowers are still atoning for that 30-year debt binge.
Deleveraging is slow, painful work and, were it not for extremely accommodative monetary policy, economic growth in the West would likely be negative.
The last earnings season in Europe was disappointing and economic data has been unremittingly poor.
The German economy has slowed and the French one is not growing at all.
Viewed in that light, this year’s repricing of high-yield bonds may seem reasonable. But has the market, from being too bullish earlier in the year, lurched too far in the other direction? This year has certainly delivered its fair share of confidence-sapping events.
The Arab Spring helped to send the price of oil sharply higher. The Japanese earthquake disrupted global supply chains.
The fiasco over raising the US debt ceiling cost the country its AAA credit rating. And throughout it all, Greece continued to lurch towards default, exposing the flaws at the heart of the eurozone project.
Given all this, it is natural companies have grown cautious and are reluctant to invest or hire new workers.
This is worrying given the corporate sector – with its healthy cash balances, cashflows and profit margins – is often seen as the saviour of Western economies.
After all, boosting expenditure by companies on investment and hiring workers is the most efficient way to boost economic growth.
So should we be worried? Recessions are generally triggered by the bursting of an asset bubble.
Assuming no such bubble exists today, valuations in the high-yield bond market look attractive.
There are fundamentally sound reasons to like high-yield bonds. Because we have only just come out of a full credit cycle, the high-yield market has been cleansed of borrowers with the weakest balance sheets.
A significant portion of high-yield debt has been cancelled or restructured and issuers haven’t had time to re-leverage.
Any reasonable assessment of the likely default rate among high-yield borrowers indicates that spreads currently offer significant over-payment for the risks investors are taking.
In my opinion, high-yield bonds compare favourably to gilts and look more attractively priced than investment-grade credit and equities.
Of course, fundamentals would pale into insignificance should the European situation spiral out of control.
In common with investors in every other asset class, we can only hope it does not come to that.
Steve Logan is head of European high yield at SWIP