The high yield market, as measured by the Bank of America Merrill Lynch U.S. High Yield Master II Constrained Index, posted a positive total return of 0.46% in February, as the high yield market finished on a positive note, after experiencing heightened volatility throughout the month.
February was a choppy month, experiencing a calm environment early on and a spike in broader market volatility and increased macro concerns later in the month. During the first two weeks of February, an overall sense of calm around macro economic conditions continued to support risk assets and allow investors to look past upcoming potential hurdles (such as sequestration.)
The Bureau of Economic Analysis’ revised estimate of the fourth quarter 2012 gross domestic product (GDP) released at the end of February was disappointing, though the originally reported decline of 0.1% has now been turned into a small increase of 0.1%. Data released at the end of February indicated the first quarter of 2013 (Q1) GDP is tracking 1.8%, compared with an average growth rate of 1.6% in the second half of 2012. The overarching theme of growth in early 2013 has been dominated by weaker consumer spending and business investment. The expiration of the payroll tax holiday on January 1st has taken a chunk out of personal income at the start of the year, and households have had to ratchet spending lower in response. Consumer spending is tracking an annual growth rate of 1.4% in Q1 compared with 2.1% in the previous quarter. Ultimately, while the last week of February introduced some reasons for investors to take pause, nothing is rising to the level of macro importance, such as Europe did last summer or the fiscal cliff did in late 2012. In the meantime, risk assets continue to be fundamentally supported by a healthy corporate earnings period, accommodative central banks, improving mergers and acquisitions, and a marginally better economic growth picture (initial jobless claims, housing, auto sales, etc.)
From a sector perspective, the Electric Generation sector continues to struggle with depressed natural gas prices. Due to the oversupply of natural gas in the U.S., we do not see this trend reversing in the near term. The Energy sector continues to enjoy improving credit fundamentals and could help in healing the U.S. labor market. There has been a massive increase in drilling for oil and natural gas in the U.S. These positive developments in the Energy sector are leading to material investment in infrastructure, which will lead to an increase in domestic job creation.
We continue to be cautiously optimistic in the high yield asset class. With global economic indicators starting to show signs of improvement, and with central bank policy action in motion, we believe that the U.S. economy will expand at about a 1.5% to 2.0% rate. We remain positive on both the return prospects and the underlying credit fundamentals of the high yield market. Companies continue to refinance higher-coupon debt, extend maturities, and focus on balance sheet repair. The quality of new issuance remains strong. In recognition of these fundamentals, inflows have also been strong. The Fed, in our opinion, may keep Treasuries in their current range, economic growth should remain steady, and defaults may remain low. In that scenario, we could see modest spread tightening and the yield of the market could end the year around where it is now. Given the positive backdrop, our base-case remains that high yield should perform well in 2013.
High yield bonds are subject to greater price volatility and may be less liquid than higher rated securities; are subject to greater sensitivity to interest rate and economic changes. As interest rates rise, the value of debt securities decreases; whereas prepayment risk tends to occur during periods of declining interest rates. The decline in an issuer’s credit rating can negatively affect the value. International investing involves certain risks and increased volatility not associated with investing solely in the US. These risks include currency fluctuations, economic or financial instability, and lack of timely or reliable financial information or unfavorable political or legal developments. These risks are magnified in emerging markets. Distressed securities are speculative.
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The Bank of America Merrill Lynch U.S. High Yield Master II Constrained Index tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market. One cannot invest directly in an index.
This material contains the current opinions of the author, which are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information used to compile this report has been obtained by sources deemed to be reliable, but its accuracy and completeness are not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Past performance is no guarantee of future results.
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