Factor 1: Despite volatile rates, high yield has generated solid returns (~+5.9% through September) driven by spread compression and strong income generation.
Inflation is improving, and there are few signs of recession, which keeps default forecasts low. Macro data, including growth and employment, are coming in stronger than expected, and corporate earnings have been resilient.
The high yield market is also benefiting from strong technical conditions, with net supply at negative $76 billion for the first three quarters, largely due to rising stars leaving the high yield space. New issuance is ahead of last year’s pace but still well behind the boom years of 2020 and 2021. High quality issuers are choosing to wait to refinance, and the new issue market has been largely shut out to low-quality issuers (less than 1% of issuance has been CCC-rated per JP Morgan).
Factor 2: Credit fundamentals are weakening off record strength but remain historically robust. Aside from distressed issuers, high-yield fundamentals remain solid.
Default risk is low for most issuers, as they have an above-average ability to pay interest and principal. Companies locked in low fixed-rate coupons when yields were low; they can now service their debt with ease. Leverage, too, remains lower than historical averages. Management teams have stayed disciplined and didn’t re-lever balance sheets despite low rates and strong earnings.
We believe these conditions will likely persist for the next couple of years. Only 12% of the market has debt coming due before 2026, giving most issuers flexibility to be patient if yields remain elevated.
Factor 3: Yields are once again “high” in the 9% range:
In the past, high starting yields have meant above-average annualized returns for the following five years. Indeed, future returns have a 0.93 correlation to starting yields historically (using the ICE BofA BB-B US Cash Pay High Yield Constrained Index).
We believe this is evidence that patience can be rewarded in this asset class, and investors should not try to time markets. Given the strong fundamentals and the high starting yield, we believe that now is still a good entry point into the high yield market.
This material reflects the firm’s current opinion and is subject to change without notice. Sources for the material contained herein are deemed reliable but cannot be guaranteed. This material is for illustrative purposes only and does not constitute investment advice or an offer to sell or buy any security. Past performance is no guarantee of future results.
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