U.S. companies have issued a record $39B of bonds in 2015 that mature in more than three decades, more than five times the amount sold in the same period last year, according to data compiled by Bloomberg.
Oracle joined the fold this past Tuesday, selling $1.25B of securities due in 2055. Another notable is Microsoft, which sold its first 40-year bond in February.
Treasurers are embracing what may be their last opportunity to lock in cheap long-term funding costs before the Fed raises rates, while investors are snapping up the longer-dated securities because they offer a higher yield over shorter-term debt.
Nobody really talks about it much, says Jeff Gundlach, but the junk-bond market's entire life has been spent in a time of secularly declining interest rates. Exactly how with these assets react once that move ends?
There's no need to sell today, says Gundlach, as the crisis he envisions is at least a couple of years away, when increasing interest rates collide with a wave of maturing paper needing to be refinanced. For now, stick with the "carry trade" of owning high-yield bonds.
“Plunging oil prices have driven nearly one out of four high-yield energy issues into distressed territory,” writes Marty Fridson, not saying whether he's a buyer here, or not. “The implied default rate for the next 12 months fits the trajectory we would likely see leading up to an industry-specific oil patch recession in 2016.”
Michael Aneiro notes the energy sector constitutes about 17% of the broad high-yield market, and both the SPDR Barclays High-Yield ETF (JNK -0.3%) and the iShares version (HYG -0.2%) are lower again on the session (even as oil has rebounded into the green).
In June - when the BAML high-yield index yield hit an all-time low of 4.86% - the energy sector yielded about the same at 4.88%. Today, with the BAML index at 6.48%, the energy portion yield has soared to 8.9%, a full 710 basis points over comparable Treasurys.
Warning about "extreme overvaluation" for some time in high-yield, Martin Fridson says the market is at long last back to being at least "moderately undervalued."
The average spread per the BAML index between junk and Treasurys has climbed to 508 basis points from a low of about 340 bps this summer, and Fridson's model of the option-adjusted spread pegs fair value at 442 bps. The 66 basis points between that and 508 represents about one-half of a standard deviation - hence the "moderately."
UBS is a buyer as well: "We believe there has been shift in the relative attractiveness between the equity risk premium and the more defensive credit risk premium, and we add to overweight position in U.S. high yield credit."
The Guggenheim BulletShares 2023 Corporate Bond ETF (NYSEARCA:BSCN) and the Guggenheim BulletShares 2024 Corporate Bond ETF (NYSEARCA:BSCO) will track portfolios of investment grade corporate funds.
The Guggenheim BulletShares 2021 High Yield Corporate Bond ETF (NYSEARCA:BSJL) and the Guggenheim BulletShares 2022 High Yield Corporate Bond ETF (NYSEARCA:BSJM) will cover portfolios of high yield corporate bond funds.
U.S. high-yield bond funds booked $680M of inflows in the week ended August 13, according to Lipper, their first weekly inflow in a month. A record $7.1B was pulled the prior week, and for the month ended August 6, a total of $12.6B was withdrawn.
“When we saw these big outflows we were looking to buy stuff,” says one fund manager, though he notes the big withdrawal numbers did little damage to prices.
Alongside the outflows has been a slowdown in borrowing, with leveraged-loan issuance of $9.7B and junk-bond sales of $2.9B this month, the lowest for the period since 201.
The high-yield market lost about 2% in July, with the average spread to Treasurys rising to 424 basis points from 353. Fridson's estimate of fair value is 467, meaning the overvaluation level has shrunk to just 43 bps from nearly 200 in late June.
Also of note, says Fridson, is a "substantial improvement" in credit availability which is a key part of his fair value calculation. The Fed Survey of Senior Loan Officers shows a net easing of credit standards read of 21.3%, nearly double that of the previous print - "the most favorable credit environment since September 2011," says Fridson.
A combined $620M was pulled from the two largest high-yield ETFs (HYG, JNK) last week, making them the least popular in the fixed-income ETF universe during that period, according to data put together by Bloomberg.
The move comes with yields on the BAML U.S. Index right around their record lows, and strategists suggest investors are cashing in some chips after a near straight-line rally over the past few months, if not years. While these ETFs are aimed at individual investors, they're increasingly being used by institutions to adjust exposure in a relatively low liquidity sector.
It definitely feels like investors are getting overexuberant, and you can stay in overexuberant conditions for a while,” says Key Private Bank's Fred Senft. "But when it turns it will turn quickly and it will turn very ugly.”
First half high-yield corporate bond issuance of $331B blew away the already perky levels of the last three years (2013's was about $250B) as yields on the BAML Global High Yield Index plumb new record lows. Even Japan's notoriously risk-averse Government Pension Investment Fund is considering scrapping its practice of only buying investment-grade paper and venturing into junk.
Senft's day of reckoning could be coming near, with junk-rated borrowers having $737B in debt needing to be refinanced or paid off in the next five years. "It's about as extreme as it gets," says Marty Fridson, who estimates spreads are about 200 basis points too tight.
High-yield debt funds raised their allocations to stocks to 3.2% at the end of March, up from 3.1% at the end of 2013 and just 2.1% one year earlier.
JPMorgan suggests investors do more of the same: “We see credit as relatively over-owned and valued versus other risk assets,” says JPMorgan. “Investors are beginning to worry about how the eventual exit will fare in a world of reduced market making by banks.”
The move comes as junk bond yields scrape record absolute lows, and on a relative basis, junk buyers are earning 346 basis points more than benchmark rates, the lowest since 2007 and 241 basis points less than the two-decade average. “We prefer to take more risk in equities and we now cut the size of our U.S. high-yield spread trade by one-third," says JPMorgan.
No longer "way overvalued," junk bonds are "way, way overvalued," says Martin Fridson, estimating fair value of the BAML high-yield index at 570 points over Treasurys vs. the current level of just 376 basis points.
He says high-yield has been in extremely overvalued territory for seven straight months, the longest streak in history. "Investors are accepting excessively small compensation for credit risk, so desperate are they to boost their yields. High-yield portfolio managers are not unaware of the inadequacy of spreads, but are willing to skate on thin ice on the assumption that the Fed is committed to rescuing them if anything goes wrong."
GMP Securities' Adrian Miller, meanwhile, is in agreement on overvaluation, but says - more or less - you've got to dance while the music's playing. A "repricing event," says Miller is not on the near-term radar.
Maybe surprising to many, long-dated investment-grade corporate bonds are outperforming junk bonds this year, with total returns already of 7.48% vs. junk at 3.3%. It's a turnaround from 2013, when high-yield returned 7.42% vs. a loss of 1.57% for IG paper.
It's good news for institutional investors like pension funds and insurers, who have been big buyers of the bonds in recent months.
In other junk bond news, DoubleLine's Bonnie Baha says the firm's core fund has cut its high-yield exposure to 3% from 6%. High prices are the reason, says Baha, noting the average price of 104.5 cents on the dollar. Many issuers can force redemptions at 103 cents, and if they don't get called, in a low-rate environment there's extension risk.
Baha takes note of the proliferation of short-duration high-yield funds. "It's a fallacy to think that just because it’s short-term that bad things can’t happen."
At 1.7% at the end of Q1, the U.S. junk bond default rate is off from 2.2% at the end of 2013, and at the lowest level since February 2008, according to Moody's. With the market yielding an average of just 5.2% (prior to 2012 it had never been below 6.5%), the default rate better stay low.
Moody's sees the default rate rising to 2.4% by year's end and 2.7% one year from now - both still well below the 20-year average of 4.5%.
It's not necessarily a booming economy, but instead welcoming debt markets which allow low-rated issuers to refinance at extended maturities and lower rates.
"There are segments of the high-yield market that do not compensate you for the risk you are taking by owning them," says BlackRock portfolio manager Michael Fredericks. Average spreads to Treasurys have fallen to just 352 basis points, the lowest since prior to the financial crisis.
There's still value, insist some managers, you just have to know where to look. "The game has changed in the high-yield market and it has become more sophisticated than it was two or three years ago," says another fund manager. Barclays chief of credit strategy Brad Rogoff, for instance, is spotting value in the high-yield paper sold by mining and retail companies, as well as the dollar-denominated bonds sold by European companies. The so-called "yankees" are on average cheaper than the boarder market, he says.
Another option is that of emerging market high-yield debt, with average yields of 7.6% more than 200 basis points higher than that of U.S. paper.
The average covenant-quality score for high-yield bonds deteriorated to 4.36 in February from 3.84 one month previous (ranking is from 1 to 5, with 5 the weakest). It's the lowest print since Moody's began tracking the gauge in January 2011.
The decline was driven by a near-record percentage of high-yield-lite bonds - 39% of issuance in February vs. just 10% in January. “These bonds lack a debt incurrence and/or a restricted payments covenant and automatically receive our weakest score of 5.0," says Moody's Evan Friedman.