In the world of fixed income, investing in high yield bonds is what’s currently in vogue. And it’s understandable given the desperate search for yield in today’s ultra-low-interest-rate environment. Due to the popularity of high yield corporate bonds, I thought it might be useful to provide a look at some of the high yield market’s internals from the month of February.
Let me begin with a look at the advance-decline ratio:
All-in-all, during the month of February, the high yield corporate bond market held up quite well from an advance-decline ratio perspective. There were only two days I would categorize as showing notable weakness (2/4/13 and 2/21/13) and one other with moderate weakness (2/7/13). Not surprisingly, those days were also days of weakness in broad-market equity indices. Interestingly, however, the single worst day of the month for stocks, February 25, was not a bad day for high yield bonds either from an advancers versus decliners perspective (almost exactly even) or from a spread widening perspective. For a closer look at February’s day-to-day changes in the “BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread,” see the table below.
|Date||Spread to Spot Treasury Curve (basis points)|
On February 25, the day of the 216 point sell-off in the Dow Jones Industrial Average and a 2.27% sell-off in the Russell 2000, the spread representing the high yield market as a whole didn’t budge. And the next day it widened just 5 basis points. This is perhaps especially surprising given the large single-day sell-off in the Russell 2000 (on 2/25), which is an index made up of small-cap stocks. Small-cap companies are those whose businesses are typically more sensitive to changes in the economy. This is also true of companies whose bonds are rated non-investment grade. Had the broader equity market sell-off (especially the small-cap sell-off) sparked serious concern among high yield bond investors, I would have expected to see the spread widen by ten basis points or more.
When digging a bit deeper into the different segments of the high yield corporate bond market, one discovers that confidence is certainly alive and well as the race for yield takes investors to the lowest reaches of junk. Although the moves in spreads across the difference segments of high yield (double-B, single-B, and CCC-and-below) were relatively small during the month of February, there is one thing worth pointing out. On a market-wide basis, the high yield spread increased 5 basis points during February, from 493 to 498 basis points. Within the individual segments, however, it is worth noting that the largest spread increase happened in the highest-rated bonds (double-B), and the smallest spread change occurred in the lowest-rated bonds (CCC-and-below).
The double-B segment of the market saw a spread increase of 8 basis points during February. The single-B part of the high yield bond market, however, rose just 4 basis points during February, and the CCC-and-below part of the market saw no change in spread. And it took a 7 basis point rise on the last day of the month for CCC-and-below to avoid having a spread contraction in February. From a spread perspective, the lowest rated high yield credits outperformed the higher rated credits during February. My hunch is that some of what I am feeling when I look for double-B bonds to purchase is also being felt by other investors—most higher-rated junk bonds now have yields that are simply unacceptably low. I, however, haven’t taken the plunge and chased yield all the way down the ratings spectrum to CCC. But it appears that other investors have.
For a closer look at February’s day-to-day spread changes in the double-B, single-B, and CCC-and-below segments of the high yield corporate bond market, see the table below (numbers represent basis points over a spot Treasury curve):
|Date||Double-B Spread||Single-B Spread||CCC-and-Below Spread|
At the end of February, the high yield corporate bond market was still holding strong despite spreads that are near the lowest they’ve been in several years and nominal yields that are incredibly low from a historical basis. Spreads can certainly still go lower—they have been much lower than they are today in each of the past two decades. But given the very low nominal yields and the fact that spreads across the high yield bond market are trading close to their post-2008 lows, at this time, I would tread carefully when putting new money to work in high yield bonds.
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