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Market View I High Yield Monthly Update

 

Views from our High Yield investment boutique, NCRAM

August 1, 2022

David Crall, CFA
CEO & CIO, Nomura Corporate Research and Asset Management Inc.


US High Yield

The US high yield market nearly completed a round trip in July, gaining 6.02% following the sharp -6.81% selloff in June, as measured by the ICE BofA US High Yield Constrained Index (HUC0). Year-to-date, the market is down -8.86%. Bonds rallied on relatively strong Q2 earnings reports from high yield issuers, along with the emerging view that a slower US economy could lead to less aggressive Fed tightening in the second half of the year, despite red-hot backward-looking inflation data. High yield spreads tightened to 485 bps at the end of July, down from an intra-month high of 601 bps on July 5. Yield-to-worst declined by 120 bps on the month, falling to 7.75%, aided by both tightening spreads and lower US Treasury yields. Sectors that lagged in the first half such as Building Materials and Cable Television were top performers in July, while defensive sectors and Energy underperformed, the latter driven by the meaningful decline in oil prices over the last six-plus weeks. Higher quality BB and B-rated bonds led the rally, while CCCs trailed the broader market by more than 100 bps.

The US Fed hiked interest rates by 75 bps at the July FOMC meeting, lifting the Fed Funds rate to 2.25-2.5%. The FOMC’s statement noted slowing economic activity, but high food and energy prices and broader pricing pressure. At the post-meeting press conference, Chair Powell remarked that he does not believe the US is currently in recession, pointing to indicators such as the strong labor market. He advised that additional rate hikes will be necessary, but “at some point it will be appropriate to slow down.” The pace of future Fed activity will be dependent on data, with the Fed continuing to focus on bringing inflation back to 2%. Despite Powell’s contra-indication, the US economy declined by 0.9% in Q2, the second consecutive quarter of negative growth, meeting a common (but unofficial) definition of recession. Most of the underperformance vs. expectations was driven by slower inventory accumulation, while inflation data continued to surprise to the upside. Headline CPI was up 9.1% y/y in June, the highest level in over 40 years. (Core CPI was up 5.9% y/y). The Fed’s favored Core PCE inflation reading rose a more modest 0.6% m/m and 4.8% y/y.

Fundamentals and technicals were supportive for the high yield market in July. Second quarter earnings reported to date have been mixed but overall better than expected, avoiding fears that earnings season would bring a steady stream of bad news. High yield issuance in the first seven months of 2022 was only $73 billion, down 78% vs. the same period last year. Calls, tenders, and maturities have taken out more than $120 billion of high yield bonds this year, thus the market is contracting. A further net $80 billion of high yield bonds have been upgraded to investment grade year-to-date, most recently T-Mobile USA’s nearly $12 billion of bonds that left the high yield market at the end of July. Inflows into the market also returned in July, with US retail fund flows registering the first net positive month this year. We are constructive on the high yield market at current levels, as issuers are generating profits and cash flow sufficient to hold the default rate comfortably below 3%, and yields in excess of 7.5% compensate investors for the risks of committing capital to high yield bonds.

 

Global High Yield

The European high yield market recovered strongly from June’s sell-off, returning 5.15%, as measured by the ICE BofA European Currency High Yield Constrained Index (HPC0) in EUR unhedged terms. Attractive valuations, a decent start to earnings season, and light street inventories contributed to the positive backdrop. While inflation remains hot and central banks continue to increase interest rates, the introduction of anti-fragmentation tools in Europe and an expectation that the Fed may be closer to neutral interest rates supported asset prices in the second half of the month. Additionally, there were several positive events affecting specific credits. While BBs led the rally and were a headwind to our portfolios’ relative performance, security selection and positive events helped us offset virtually all of this ratings-driven drag.

Emerging markets hard currency sovereign bonds, as measured by the JPMorgan Emerging Markets Bond Index Global (EMBIG), rose 3.20% in July (-16.23% YTD). High yield credits underperformed in July despite gaining 2.92%, while investment grade sovereigns outperformed with a 3.38% gain. The EMBIG index spread over US Treasuries tightened by 14 bps to 446 bps. The combination of stronger US Treasuries and a bounce in global equity markets, despite weakening economic data and ongoing inflation concerns, was the main driver for the strong overall performance in emerging markets in July. EM high yield corporate bonds, as measured by the ICE BofA High Yield US Emerging Markets Corporate Plus Index (EMUH), rose 1.35% in July and have declined -18.19% YTD. Asia high yield underperformed again in July (-2.41%) on persistent macroeconomic headwinds in China. The EM corporate market ended July with a yield-to-worst of 10.95% and 812 bps spread over US Treasuries.

 

Disclosures
This document is prepared by Nomura Corporate Research and Asset Management Inc. (NCRAM) and is for informational purposes only.
All information contained in this document is proprietary and confidential to NCRAM. All opinions and estimates included herein constitute NCRAM’s judgment, unless stated otherwise, as of this date and are subject to change without notice. There can be no assurance nor is there any guarantee, implied or otherwise, that opinions related to forecasts will be met. Certain information contained herein is obtained from various secondary sources that are believed to be reliable, however, NCRAM does not guarantee its accuracy and such information may be incomplete or condensed. Historical investment performance is no guarantee of future results. There is a risk of loss. Strategy performance references are based on gross of fees performance.
Certain information contained in this document contains forward-looking statements including future-oriented financial information and financial forecasts under applicable securities laws (collectively referred to herein as forward-looking statements). Except for statements of historical fact, information contained herein constitutes forward-looking statements. Although NCRAM believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, it can give no assurance that forward-looking statements will prove to be accurate. These statements are not guarantees of future performance and undue reliance should not be placed on them. Forward-looking information is subject to certain risks, trends, and uncertainties that could cause actual performance and financial results in future periods to differ materially from those projected. NCRAM undertakes no obligation to update forward-looking statements if circumstances or NCRAM’s estimates or opinions should change.
This document is intended for the use of the person to whom it is delivered. Neither this document nor any part hereof may be reproduced, transmitted or redistributed without the prior written authorization of NCRAM. Further, this document is not to be construed as investment advice, or as an offer to buy or sell any security, or the solicitation of an offer to buy or sell any security. Any reproduction, transmittal or redistribution of its contents may constitute a violation of the U.S. federal securities laws.
Performance data is calculated by NCRAM based upon market prices obtained from market dealers and pricing services or, in their absence, an estimate of market value based on NCRAM’s pricing and valuation policy. Performance data stated herein may vary from pricing determined by an advisory client or by a third party on behalf of the advisory client. Performance data set forth herein is provided for the purpose of facilitating analysis of account assets managed by NCRAM, and should not be used for the purpose of reporting or advertising performance of specific account portfolios to account beneficiaries or to third parties.
An investment in high yield instruments involves special considerations and certain risks, including risk of default and price volatility, and such securities are regarded as being predominantly speculative as to the issuer’s ability to make payments of principal and interest.
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The views and estimates expressed in this material represent the opinions of NCRAM and are subject to change without notice and are not intended as a forecast or guarantee of future results. Such opinions are statements of financial market trends based on current market conditions. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provided, and should not be relied upon as legal or tax advice.
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