15th September 2020

💷 HY Strategy: 17.5% Returns after 5 months

Market Overview

While the equity markets rediscover themselves following that tech-led September sell-off, the credit market hasn’t quite been affected in the same way, or in a way we might have anticipated. That is, higher volatility and a sharp drop in equities usually means wider spreads, especially in higher beta markets. We haven’t seen that.

Instead, spread markets almost across the board have been firm, resolute in the face of the pressure elsewhere (equity market valuations, corporate profitability, a constant feed of geopolitical rumblings, macro uncertainty and so on).

Flow, volumes and investor interest to transact in the secondary market is, well, secondary to the need to get some more risk on board – but through the primary market. IG has a habit of receiving all of the attention and gets all the headlines. But the HY pipeline is building and we are on course for this to be – quite amazingly – a record year for issuance in the euro denominated HY corporate bond market. Another €18bn between now and year-end will do it.

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 recovery phase. The ECB stayed pat last time out, but there will be a call to arms sometime in the fourth quarter (extending expanding existing QE schemes and/or further monetary policy easing) – especially if a second wave materialises through the autumn/winter months.

In the meantime, credit markets have reopened after the summer break. Primary is the only offer in town, for those fortunate enough to receive an allocation. Issuance volumes are going to be elevated over the next few weeks, and it should inject enthusiasm into the corporate bond market, coinciding hopefully with an upbeat equity market.

September has reopened with €5.3bn of HY issuance in the first couple of weeks, taking the volume of deals up to an impressive €58.7bn of issuance year to date (see chart).

High Yield Issuance

As measured by the iBoxx HY index, spreads are just 7bp tighter on the index for September with the index now at B+450bp. Returns since the beginning of August are at +1.8%, leaving them to recover to -2.2% 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 had decompressed in X-Over/Main to 6.3x during August, but we have seen a resumption of the compression between the two indices, now at 5.83x. 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 325bp (see chart).

HY/IG Spread Compression

The going tighter in spreads is on and a sub-300bp level on that compression between HY and IG cash indices is still quite possible sometime in Q3/4. We think the high yield index can tighten to below B+300bp through Q4. We also think that the IG index might see a sub-B+110bp level.

Since starting the CreditMarketDaily.com Sterling HY Portfolio, in the middle of April, our investments have recorded total returns in the five-month period of 17.5%. It is outperforming when compared against the iBoxx index, which has returned 9.1% for the euro-market (and 10.7% in £ HY).  You can follow our portfolio progress for free here.

We have just doubled our NewDay (7.375%, 01 Feb 2024) holding.

This second batch of NewDay bonds was acquired at a sub-par price of £93.50, which is a lot higher than the previous investment made at £72.00 but we still believe that it’s worthwhile. In addition to NewDay, our holdings also comprise Saga, Iceland, TalkTalk and Shop Direct  – credits which are at the testier, more high-yielding spectrum of the high yield market.

The US elections will probably be the next potential source of severe market volatility. We are weeks away and so markets could eke out some good gains as we head into a more turbulent period. Virus vaccine hopes are improving while the macro data is probably going to be more hit than miss as we recover from the devastation wreaked by the pandemic.

So we stay positive for credit. There is cash to put to work and inflows into funds continue. Investors remain comfortable in funding the corporate sector. The low rates forever narrative is an important one as the flow of cash into the corporate bond market its supported by it, while we are yet to see a material rise in corporate delinquencies across Europe, and the dreaded default rate rise.

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.