Is there trouble brewing in the junk-bond market?
Blogger Wolf Richter of Wolf Street certainly thinks so, as he illustrates in the chart below showing how yields at the low end of the junk bond spectrum have surged to more than 15% this year from an average of 8% in mid-2014.
What’s driving the trend is growing risk aversion as the credit cycle comes to an end and the Federal Reserve gets ready for its first interest-rate increase since 2006.
“Finally seeing some of the risks, investors are transitioning from loosy-goosy, everything-goes — a formula the Fed has espoused since 2008 through its destruction of yield — to a sense of caution or even foreboding. And they’re beginning to pull back,” Richter wrote Friday in his blog.
At first, junk-rated energy, mining and metals companies took the brunt of the selling, but in the last two months it has spread to other sectors, such as retail, pharma and media. And that has made portfolio managers nervous, said Richter.
Read: Oil’s slump played havoc in U.S. junk-bond market in September
The least risky junk bonds — those rated in the BB category — have held up relative to the lower end of the curve. Their average effective yield has risen to 5.85% from about 4.3% in mid-2014, according to the Bank of America Merrill Lynch U.S. High Yield Index.
But as risk aversion builds steam, spreads are widening in that part of the curve, too, according to Marty Fridson, chief investment officer at wealth manager Lehmann Livian Fridson Advisors LLC.
The option adjusted spread between the B. of A. Merrill Lynch BB U.S. High Yield Index and the B. of A. Merrill Lynch B U.S. High Yield Index has reached its widest point since the end of the Great Recession, Fridson wrote in a report published by LCD. The spread stood at 250 basis points on Tuesday, compared with an average of 160 basis points in the period from June 30, 2009, to now.
“High-yield portfolio managers are seeking to minimize sudden, multi-point losses by huddling at the top range of quality,” said Fridson. “The BB sector has become a crowded trade.”
Meanwhile, there is feverish mergers-and-acquisitions activity as companies and the banks that advise them rush to get in before the window closes — when stock and bond markets deteriorate and make it harder to raise capital.
See: Pfizer-Allergan tie-up news pushes M&A to record level for 2015
Pfizer Inc.’s $155 billion deal to acquire Allergan Inc. AGN, +2.74% this week is a prime example of a deal that will likely lead Pfizer PFE, +2.92% to issue a ton of new debt — not to fund the acquisition, but to pay for the large share buybacks it will need to alleviate post-merger dilution, according to Richter. That explains why Standard & Poor’s has placed Pfizer’s AA rating on review for a possible downgrade, he said.
Corporate deal makers realize that lower-rated companies are struggling to issue debt at sustainable rates and are aware of rising defaults and that a few megacaps are holding up the S&P 500. “And so they’re furiously making hay as the storm is moving in,” said Richter.
Moody’s has already warned that there will be trouble when the flood of junk debt that has hit the market in the last few years starts to dry up and defaults rise. The U.S. high-yield market totals about $1.8 trillion today, or nearly double the $994 billion outstanding at the end of 2008, according to Moody’s.
http://www.marketwatch.com/story/junk-bond-yields-are-soaring-and-the-fed-hasnt-raised-rates-yet-2015-11-25?siteid=rss&rss=1
