The Outlook for High Yield: September 2019

Friday 13 September 2019

Perspectives

The high yield market this year has benefited from lower interest rates, but also faced headwinds from fears of an intensifying trade war and its potential impact on global growth. While we remain confident that strong US consumer demand will keep US growth on a positive trajectory through year end, trade issues are beginning to have an impact on business confidence and, therefore, business spending. Growth is already slowing in Europe, as evidenced by the 2Q19 modest decline in German GDP. Although we expect emerging markets (EM) to find lower US interest rates beneficial, EM economies are highly export-oriented and will face headwinds from trade wars.

When we consider the outlook for global high yield, it is important to remember US HY remains the largest component of the global high yield market, at 60%, while Euro High Yield and Emerging Markets Corporate High Yield are about 18% and 22%, respectively. We make the following observations about the state of the Global High Yield market:

  • Strong Year-To-Date returns although mixed August returns: all Global High Yield regions have posted positive returns year-to-date through the month of August. The ICE Bank of American Merrill Lynch U.S. High Yield Index is up 11.2%, the ICE Bank of America HY U.S. Emerging Markets Corporate Plus Index returned 8.9% while the ICE Bank of America Euro High Yield Index returned 9.4%. August returns for US HY were breakeven (+0.4%), modestly positive for Euro HY (+0.7%) and modestly negative for EM Corporate High Yield (-1.6%).
  • HY fundamentals remain healthy: we do not see any of the aggressive high yield borrowing behavior we saw prior to the 2008/2009 recession.
  • YTD US HY mutual fund flows are still positive: the recent spread widening and decline in global interest rates have increased inquiries from institutional clients. Demand appears solid.
  • Quality has performed: the markets are distinguishing between those sectors and companies less exposed to cyclical and secular risks. As a result, BBs have outperformed and CCCs have lagged significantly.1
  • Most US HY companies are domestically-focused rather than export driven, so they are less exposed to the more immediate impact of the trade war.

Considering our observations surrounding today’s high yield investment climate, our outlook and some insights on our positioning is below:

  • Spreads are unlikely to get much tighter: we believe we have seen the post-recession low in credit spreads which was 364 basis points in April for the U.S. High Yield Index.
  • High Yield carry remains attractive: coupon income, or carry, is around 50 basis points (bp) a month, based on year-to-date performance for the U.S. High Yield Index Index. An increasing proportion of the global bond market is trading at negative yields. Even if one avoids investing in CCCs, carry has been around 40bp per month year-to-date through the end of August.
  • Differentiation between winners and losers will likely increase: the markets are already distinguishing between better quality credits (BBs) and lower quality ones (CCCs). We foresee rising defaults in low quality energy companies and expect more credit pain in retail.
  • Volatility will remain elevated: trade uncertainty will continue, which will trigger periods of market volatility.
  • The 2020 US election year will likely elevate the level of volatility: the closer we get to 2020, the more election year uncertainties are likely to grow.
  • It is time to go “neutral but…
    • there will be opportunities to trade the increased volatility. We are confident we will periodically see real bargains.
    • we believe Global High Yield should compare well to other asset classes.

 

Summary

Trade tensions have led to slower economic growth and lower interest rates. We expect trade turbulence to continue and we expect this turbulence to generate challenges and opportunities. Global High Yield has a very broad opportunity set compared to its regional components and we expect to see solid opportunities to generate relative performance as macro headwinds create opportunities to pivot between regions. We continue to believe that, even with slower growth due to trade tensions, high yield will continue to be an important part of a broadly diversified portfolio.

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Unless otherwise stated, all information contained in this document is from Amundi Asset Management and is as of 31 August 2019. The views expressed regarding market and economic trends are those of the author and not necessarily Amundi Asset Management, and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Amundi Asset Management product. There is no guarantee that market forecasts discussed will be realized or that these trends will continue. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any services.

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