16th August 2020

💷 HY Strategy Portfolio: 14.2% returns in 4 Months

Market Overview

Mid-August greetings – and what a surprise. The US equity markets are toying with a record high in the case of the S&P index. Other markets are feeding off it, rising tides and all that. Should it be so? We’re still gripped by the coronavirus pandemic, as well as the timing of potential for the development of an effective vaccine (facing continual lockdowns, and closing air bridges etc).

There’s also plenty of uncertainty in the West (and others) versus China on a whole host of issues. The US election is also now firmly in view and market volatility in the weeks around it could be something else.

That aside, easier liquidity conditions are here – forever, it seems; In fact, we’re going to see said conditions ease more. That is, there’s more stimulus coming. That money will need a home, so look for ‘the bubble’ to inflate some more and valuations to continue to not fit with any historical models. The message is clear – don’t fight it, chase it. Look for a good run into year-end.

There are signs of life in macro but we’re by no means knocking the ball out of the park in terms of the recovery. There’s no ‘V’ but we are in some sort of a tentative up-trend. We are through the second-quarter earnings season without too much fuss, while the disappointment in the Q2 data in macro was as expected.

Looking forward, we expect that credit markets will reopen through the last week of August. Primary will be the only offer in town. We expect that issuance volumes will be high and it will inject a decent amount of enthusiasm into the corporate bond market, adding to the squeeze in spreads that we have seen this past couple of weeks.

There hasn’t been a single deal yet this month in high yield, but we’re still up at an impressive €50.6bn of issuance year to date and given the disruption this market has had this year, we are likely looking at a record year for high yield corporate bond issuance in Europe (just €26bn needed between now and year-end). Mind, there hasn’t been a single deal in August anywhere in the euro-denominated corporate bond market!

High Yield Primary Issuance

There has been an impressive squeeze in spreads. In IG, the iBoxx IG cash index is now at B+124bp, which is 12bp tighter in August and now just 20bp wider year to date. It has been as wide at B+260bp! Returns have dipped into the black again too, year to date.

As for HY, spreads are 40bp tighter on the index for August with the index now at B+456bp, returns in the two weeks coming in at +1.2% and recovering to -2.8% year to date. The market is well off the floor. Index spreads have recovered 50% versus their wides this year, and are only 100bp wider year to date.

High Yield Bond Index

The high/low beta compression has moderated (and decompressed in X-Over/Main to 6.3x). The Markit iBoxx index spread between the HY and IG indices gapped from a little over 200bp at the beginning of the year to almost 650bp at the worst of the market’s reaction to the pandemic. Since the ‘recovery’ set in, we have seen a crunch tighter in high yield spreads versus IG and that difference is now at around 332bp.

HY/IG Spread Compression

A sub-300bp level on that compression is still quite possible sometime in Q3/4 and we think the high yield index can tighten to below B+300bp through Q4. We also think that the IG index might see that B+104bp level again, too.

Since we started our CreditMarketDaily.com Sterling HY Portfolio, around the middle of April, our holdings have recorded total returns in the five-month period of 14.22%. Compare this against the iBoxx index, which has returned 10.3% (for € market and 10.0% in £ HY), it is outperforming.  You can follow this for free here.

Our holdings so far comprise NewDay, Saga, Iceland, TalkTalk and Shop Direct  – credits which are at the testier, more high-yielding spectrum of the high yield market.

New Day reported H1 2020 up slightly while EBITDA dropped by £100m to -£35m in the six months (impairments increased). The balance sheet, though, was fairly resilient with cash up and net debt slightly lower as at the end of June 2020.

Talk Talk’s Q1 trading update saw a coronavirus impact on revenues (-7.5% versus 2020) with news that there will only be a limited impact of the pandemic on revenues.

Iceland, like most big good retailers, has weathered the pandemic well. The group’s balance sheet was unchanged (cash at £140m), capex fell sharply with the EBITDA leverage ratio likely to remain at around the 4-5x area.

Shop Direct came up with an upbeat trading statement (year end 30/6/2020) as consumers have switched to online retailing through the pandemic, with sales up by 36% in the last quarter and revenues for the full year likely to exceed £2bn. Expectations by the group are that EBITDA will come in the £255m – £270m range, with a commensurate strengthening in the group’s balance sheet.

The Shop Direct 7.75% Nov 2022 issue can be called on Sept 16 at a price of 103.875 (currently 95 bid). The high yield market is in good form and if current issuance market conditions remain as favourable at that point, expect the £550m issue to be called and refinanced – at a cheaper level.

Overall, market direction will depend on the macro recovery dynamics which will be propped up by the next policy response, first likely by the Fed (in September), with the market already anticipating something from the BoE as well. Probably more QE from both given their aversion to negative rates.

We still like the market here, and look for those expectations/measures to bolster the demand for risk assets and a continued recovery in prices/spreads into year-end.

Suki Mann

A 30+ year veteran of the European corporate bond markets and in his role as Credit Strategist, Dr Mann has been ranked number one in the Euromoney Investor Survey eight times in ten years. Previously with Societe Generale and UBS, he now shares views of events in the corporate bond market exclusively here on CreditMarketDaily.com.