2018 Outlook: There's still gas in the high-yield tank

12-22-2017

High-yield bonds delivered another year of strong performance in 2017, with the benchmark Bloomberg Barclays US Corporate High Yield 2% Issuer Capped Index returning 7.2% as we approached year-end. After such a long, positive run, can investors expect more of the same in 2018? We believe the answer is “yes” and anticipate solid returns for the asset class relative to other fixed-income alternatives.

There’s good reason to be optimistic. The global synchronized economic expansion, a business-friendly administration in Washington, solid corporate credit quality, modest default activity, robust equity markets and a favorable supply-demand balance set a strong backdrop for high yield in the New Year. Valuations are the only less-than-ideal factor, with high-yield spreads versus Treasuries—the difference between yields on comparable maturity securities—running around 400 basis points. Trough levels historically have been in the low 300 basis-point range. But a continuation of favorable economic growth and low default levels—which we expect—and measured Federal Reserve tightening—which we also expect—should support more narrow high-yield bond spreads for some time to come.

All told, we see another coupon-driven year for high yield with total returns of about 6% possible as spreads tighten in line with anticipated modest increases in interest rates. Likewise, any small increase in default activity is likely to be offset by an increase in merger & acquisition activity and equity initial public offerings (IPOs). Bottom line: with Treasury yields expected to modestly rise (and prices to correspondingly decrease) over the course of 2018, we think high yield is an attractive place to be in the fixed-income space.

Mark Durbiano
Mark Durbiano, CFA
Senior Portfolio Manager, Head of Domestic High Yield Group, Head of Bond Sector Pod/Committee