Yes to the first two and nay to the last part. Today
, the Barclays US High Yield Index dropped below 5% for the first time ever on top of record issuance year-to-date. As a whole, the credit situation of US companies hasn’t changed much over the past five months. Default rates remain low at 2.6%, below the 6% long run average; with unending easy global monetary policy, it seems that the chances are even lower that we rise above that level, despite consumption growth continuing to slow amidst higher taxes.
However, it isn’t the first time that high-yield bonds have made record low yields this year. More importantly, on a spread basis, high yield still has a ways to go the upside on a relative basis. With Treasuries at record lows (and likely to remain near there with low growth and inflation forecasts), effective yields will continue to remain at these low levels. According to the Bank of America-Merrill Lynch Master II OAS index, high-yield bonds currently have a spread of 424bps over Treasuries. In mid-2007, these spreads reached record lows of 248bps, so technically there is upside left. Not that I’m saying I would buy here, but I am just pointing out the perspective.
US high-yield issuance year-to-date currently stands at $154.6 billion, ahead of the $131.5 billion at this time last year, according to Mischler Financial. Usually with increased issuance, yields would fall, but with the continuous demand lately, that has not been the case. Granted, a sizable portion of this issuance has been used to refinance older, higher coupon debt, which is a credit positive for these companies.
Much has been made about an epic "Great Rotation" from bonds into stocks this year. Of course, asset allocation is a bit
more complicated than that. There has been no shift, as every asset class with the exception of commodities has gone up this year. Anyway, let's look at the numbers. The S&P 500
(INDEXSP:.INX) has returned 15.05% this year with dividends while high yield has only returned 5.3%. Clearly it shows that stocks have been the best performer.
Demand for credit is starting to look a little frothy, though. The 3-part BB- rated General Motors
(NYSE:GM) offering yesterday was said to have an order book of $25 billion, which was 12.5x the initial offering size of $2 billion. Also, initial price talk on the deal put the 5-year note at a coupon of 3.5% - 3.75%, and the 10-year at 4.50% - 4.75%. The final pricing was 3.25% and 4.25% respectively.
Other silly speculative grade offerings include a deal from B- rated Sonic Automotive
(NYSE:SAH) on Monday. The automotive retailer sold $300 million of 10-year senior subordinated
debt at a 5% coupon to refinance an existing 9% 8-year note it sold three years ago. Sonic sports a not-so-tasty net debt/EBIT ratio of 7.32.
So I would say that high-yield bonds are both "junk" and "speculative," but do not offer the "high yield" to justify the credit risk investors are taking with these companies.
In other bond market news, the Treasury sold 4-week bills at an effective yield of 0% yesterday. Over the recent months, due to increased tax receipts, bill issuance has declined. Four-week bill issuance now stands at $20 billion, down from the $45 billion, $40 billion, and $30 billion levels from the prior weeks. Also, 3-month and 6-month bill issuance has declined to a weekly total of $53 billion from $65 billion. Accordingly, short-term bill yields have declined as demand remains constant.
Tomorrow will be the last day of Treasury coupon issuance
for three weeks before the Treasury issues 2-year, 5-year, and 7-year notes in the last week of May. This will provide a tailwind for Treasuries. In addition, seasonality in Treasuries typically turns bullish by Memorial Day. In a study I conducted of 10-year Treasury yields back to 1970, yields rose during the month of June 45% of the time, compared to 64% of the time for March and 60% of the time April. See the below chart, courtesy of Deutsche Bank, on daily net treasury issuance and its effect on rates for some perspective.
Investor Positioning and Flows, Deutsche Bank, May 3, 2013
No positions in stocks mentioned.
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