Yes to the first two and nay to the last part.
, 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
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
(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
) 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-
) on Monday. The automotive retailer sold $300 million of 10-year
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
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
Investor Positioning and Flows, Deutsche Bank, May 3, 2013