26th November 2020

💷 HY Strategy: 20.2% Returns Since April

Market Overview

We are into the home straight for 2020, but one can be forgiven for thinking that the roller-coaster ride might still have a few twists and turns to come yet. As it stands, markets have staged the most incredible of recoveries. There has been much hope littered with periods of fear. Everything has been smoothed over by lashings of central bank liquidity and more recently, the coronavirus vaccine news.

Risk market prices had hit rock bottom back in that early March/April period, but without quite falling out of bed. But we go into the final weeks of the year with the US markets at or around record highs. European markets are at or around being in the black for the year.

Rates have remained better bid throughout. Credit spreads in IG are remarkably flat year to date and we are in positive territory in total return terms in IG and HY (iBoxx index).

(Bit) coining it in

The stand-out market though is a non-standard market. It’s the crypto sphere – and Bitcoin in particular. Given huge credibility afforded by Paypal’s most recent participation in the crypto currency, we have seen a remarkable – almost exponential, rise in Bitcoin’s price. It’s not for the faint-hearted, though.

Its price has taken a hammering in Thursday’s session, losing 10% (or $2k per coin) in what is probably a correction, but is still higher by 300% since March, generating option-like returns for investors. Now it’s at around $17,000 USD a coin and some forecasts have it pitched up at more than $100,000 a coin by the end of 2021.

The expected recovery

Every time we have seen life in macro, the next virus wave has stopped it in its tracks. So we are looking at a double-dip recession. That’s all looking back. We have several vaccines in production and awaiting final regulatory approval before being disbursed. Life will be back to normal sometime, perhaps through the second quarter of 2021.

Macro won’t hit it out of the park. Too much has been broken. The numbers, though, will look good because we’re coming off such a low base, but all that additional indebtedness needs to be serviced/repaid. But at least the economic machinery can get back to work and hopefully in a sustainable fashion. That is, lower growth and low rates forever.

Until then, markets will try and get ahead of the curve. So we expect rising markets. Equities will go higher – the US equity indices will set new records. We could expect some of the European bourses to do the same. Depending on the Brexit outcome, the FTSE index looks like being an outperformer.

Into that better tone, credit markets should see spreads continue to tighten. There’s a good chance that IG spreads see new records (iBoxx index), that compression between high and low beta give a kicker to HY markets and we squeeze considerably (no records).

Surprising Performance

The corporate bond market has been flying during the final quarter. The primary market issuance dynamic has seen a slowdown, but we are still in record issuance territory for both the IG and HY markets. That’s a complete surprise in the case of the latter, given that the classic support mechanisms for the high yield market – derived from macro growth boosting revenues and debt serviceability – have seized up.

Needs must. There’s cash to put to work. And support has come from various outlets (easier policy, direct government support, covenant waivers and the like). The chart below shows the record supply with most likely 4 weeks of business still to go. We are probably now thinking the final volume total to exceed €85bn for 2020. We’ll have to go some to beat that in 2021.

High Yield Issuance

As measured by the iBoxx HY index, spreads are a stunning 120bp tighter on the index for November with the index now at B+375bp. Returns for November are at +4.3%, leaving them to recover to +1% year to date as the HY market has managed to haul itself off the floor. Index spreads have recovered nearly all of their pandemic-related losses, only 30bp 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 5.4x. 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 270bp (see chart).

HY/IG Spread Compression

The going tighter in spreads is on and a sub-250bp level on that compression between HY and IG cash indices is still quite possible by year-end. We think the high yield index can tighten to below B+345bp through Q4 (now at B+375bp). The IG index is flat year to date at B+104bp.

Portfolio Outperforming

Since starting the CreditMarketDaily.com Sterling HY Portfolio, in the middle of April 2020, our investments have recorded total returns in the seven month period of 20.2%. It is outperforming when compared against the iBoxx index, which has returned 14.6% for the euro-market (and 16.1% in £ HY), in the same period.

You can follow our publicly available portfolio’s progress here.

Our rather limited holdings comprise NewDaySaga, Iceland, TalkTalk and Shop Direct  – credits which are at the testier, more high-yielding spectrum of the HY market.

I hope that regular readers of creditmarketdaily.com have also been able to catch some of the uplifts on these bonds.

There is no sign of anyone running for the hills. Markets are managing to find their way through the pandemic and will get through the morass facing them over the next 3-5 months. Positioning for that will underpin valuations.

The ‘low rates forever’ narrative is an important one as the flow of cash into the corporate bond market is a consequence of it, while we are yet to see a material rise in corporate delinquencies across Europe (if indeed we do see one).

So the omens are positive for the corporate bond market and the compression trade could see the HY market continue its recent outperformance.

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.