A recap of the high yield bond market in August truly has two distinct
chapters, aligning with the stark contrast in market activity (or lack thereof)
between the first and second half of the month. The first chapter saw a bout
of downside volatility creep back into the marketplace, a little “fire and fury”
if you will, as spreads gapped +36bps wider over the course of a couple days.
With Kim Jong Un rattling his saber abroad and political/policy stagnation
taking hold at home, the ingredients for a traditional risk-off cocktail began
to coalesce. However, the sell-off that ensued proved very technical in nature
(indigestion from an accelerated new issue calendar compounded by broad
based ETF selling). Indeed, price declines were initially pretty even across
sectors and ratings categories, indicative of an indiscriminate re-pricing rather
than a more discerning risk-off/flight-to-quality trade. As the tape quieted
in the second chapter of the month, however, fundamentals began to peer
through, driving name, sector and quality specific price action. Evidence of
decompression across fundamental lines started to emerge, reinforcing our
position that security selection (discerning between the winners and losers)
with a focus on relative downside risk will be key to outperforming at this
point in the credit cycle.
Indiscrimate Selling Initially was Followed by More Discerning
Price Action Later in The Month
Source: Bloomberg
MARKET PERFORMANCE
Carry and duration offset much of the negative impact from spread widening during the month, though fell a bit short as
total return in August ultimately finished in the red. High yield bonds returned -0.04% in August, with spreads +26bps
wider by month end (+36bps in the first two weeks offset by a -10bps grind tighter for the duration of the month).
Across ratings buckets, higher quality bonds were the only cohort to generate a positive total return this month. Greater
interest rate sensitivity and a grab for safer, cash-surrogate risk towards the end of the month lifted BB bond prices off the
lows set in early August, while CCC rated risk continued to languish following the initial sell-off.
Credit Spread Widening Weighed on HY Bond Performance in August
Source: Barclays
As alluded above, several issuer and sector specific events during the month began to drive meaningful bifurcation
in performance across credits. The Fresh Market and other levered supermarket bonds continued to trade lower
in August after initial fears of the Amazon effect on industry economics (competition, deflation, margin erosion,
etc.) were at least partially confirmed.Price cuts announced at Whole Foods ranged across numerous items with
initial spot checks identifying price cuts consistently in the 40-50% range. Windstream bonds (and stock) also sold
off meaningfully during the month, with the other ILECs gapping lower in concert (Frontier, CenturyLink), after the
company announced a surprise end to its dividend. The declines signaled concern over the company’s mediumterm
liquidity position and reignited fears regarding the secular challenges facing the sector. Oil-levered credits
underperformed as weak commodity prices, both spot and futures, compounded already wavering sentiment
following generally underwhelming second quarter results. Notably, higher beta energy credits (Servicers and E&Ps
with subpar acreage/basin exposure and high costs of extraction) continue to meaningfully underperform higher
quality comps as investors temper expectations for a sustained recovery in oil prices. On the other end of the
distribution, Transportation Services, specifically Hertz, Avis and auto dealers, received a jolt as investors priced in
the prospective benefits from Harvey and Irma to used car sales, dealer inventories and residual values. IPPs also
outperformed following Energy Capital Partners announced acquisition of Calpine, sparking renewed focus on nearterm
credit enhancing M&A optionality in the merchant power space.
Source: Barclays
MARKET TECHNICALS
High yield funds, particularly ETFs, saw fairly meaningful net outflows, totaling -$3.3bn, during the month. The selling
pressure was most pronounced in the second week of the month as geopolitical tensions weighed on retail risk appetite
and the heavy new issue calendar (discussed below) likely incentivized institutional portfolio managers, who utilize HYG
for cash management purposes, to reduce holdings of the ETF. Outflows did subside as the month progressed and
rhetoric out of North Korea and the White House calmed, easing technical pressures and supporting the late month
grind higher in higher quality credits. Dealer inventories painted a similar picture throughout the month: They rose amid
the outflows and secondary selling against the heavy new issue calendar. Then they sharply contracted back toward the
lows of the year as investors put cash back to work in a sparsely populated marketplace.
A Stretch of ETF Outflow Mid-Month Indiscriminately Pressured Market Prices
Source: Lipper, JP Morgan
Dealer Inventories Remain Near YTD Lows Ahead of Historical Active September Trading/Issuance
Source: Barclays
In contrast to light new-issue activity in July, the primary market was open for business during the first half of August
(before shuttering in the final two weeks of the month). Approximately $19bn in USD-denominated debt cleared the high
yield market before August 18th, keeping pace with the near-record-setting March calendar. Commodity sensitive cyclical
and structurally challenged credits crowded the calendar with deals being funded at still fairly reasonable costs of capital.
The standout deal of the month was undoubtedly the Tesla senior notes which priced at par to yield 5.3%; an interesting
benchmark bond to track going forward. Taking stock of new issue performance mid-month, results were mixed with
several deals trading below issue price as heavy issuance in a short window weighed on the market.
August Saw Above Average Issuance Crowded into the First Two Weeks of the Month
Source: Credit Suisse
High Yield Met Supply ($M)
Source: Barclays
FUNDAMENTAL TRENDS
August witnessed zero high yield borrowers default on their obligations, following similarly de minimis default activity
in July (recall, loan-only borrower True Religion and distressed retailer J Crew filed Chapter 11 and effected a distressed
exchange, respectively). While defaults were nonexistent in August, the level of stress in the marketplace (defined as
the par value of bonds trading >1,000bps) did notch higher during the month. Indeed, with CCCs underperforming,
particularly in the Energy patch, and secularly pressured credits re-pricing sharply lower (Wirelines, Retail /
Supermarkets), the level of stress and the level of dispersion in high yield credit is quietly increasing.
The HY Distressed Ratio Increased +130 bps in August to 7.3%
Source: JP Morgan
....And Bond Level Dispersion Is Rising As Well
Ratios of the inter-declie range, differential between the 90th and 10th percetiles, to the median spread across the bond constituents
of iBoxx IG and HY indicies.
Source: iBoxx, Goldman Sachs Global Investment Research