Still a tad cautious on high yield Still a tad cautious on high yield\images\insights\article\proceed-with-caution-small.jpg June 4 2020 June 4 2020

Still a tad cautious on high yield

The dichotomy between market tranquility and abundant uncertainty has us remaining highly selective.
Published June 4 2020
My Content

Despite coronavirus-related turbulence, the risk-on rally continues in full force.  From equities to high yield, returns were robust for a second straight month in May, with massive government stimulus and intervention in financial markets helping push prices higher. Now that the economy is slowly reopening and treatments and vaccine developments are accelerating, there is hope the worst may be behind us. To that view, we would say: let’s not get ahead of ourselves.

In May, the high-yield market as measured by the Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index returned a very robust 4.37%—and that was on top of April’s even stronger 4.53% return. Interestingly, after collapsing in March, the Energy sector has been a key driver of high yield so far in the second quarter, with independent energy up over 44%, midstream up over 33% and oilfield services up over 17%. It wasn’t very long ago that the top question from our investors was how much of that evil Energy sector did we own. To be fair, the strongest performers were some of the newly minted high-yield Energy names—that is, those that were formerly investment grade. Occidental Petroleum was one such newcomer, leading the way after entering the Bloomberg Barclays high-yield index at the end of March along with Western Midstream, its majority-controlled midstream operation. Those two very large issuers made up over 2% of the index as of the end of May and scored significant returns over the past two months. 

What next?

We may have left some gains on the table by not aggressively adding high-yield exposure to our fixed--income multisector portfolio model when the market was struggling in mid-March. But we remain modestly underweight given our view the market may be moving too far, too fast. Default rates are rising, led by Energy, and that seems to be broadening—think J.C. Penney and Hertz, among many others. Bottom line, we believe we are not yet out of the woods and are staying alert as current market levels may be pricing in a too-positive, too-soon endgame. While it’s tough to fight the Fed, we believe fundamentals will again matter in an economy whose recovery is likely to be slow and uneven.

Tags Coronavirus . Fixed Income . Markets/Economy . Active Management .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Past performance is no guarantee of future results.

Bloomberg Barclays US Corporate High Yield 2% Issuer Capped Index: The 2% Issuer Cap component of the US Corporate High Yield Bond Index. Bloomberg Barclays US Corporate High Yield Bond Index is an unmanaged index which measures the USD-denominated, high yield, fixed-rate corporate bond market. The index follows the same rules as the uncapped version, but limits the exposure of each issuer to 2% of the total market value and redistributes any excess market value index wide on a pro rata basis. The index was created in 2002, with history backfilled to January 1, 1993. Indexes are unmanaged and investments cannot be made in an index.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Diversification and asset allocation do not assure a profit nor protect against loss.

High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risk and may be more volatile than investment-grade securities. For example, their prices are more volatile, economic downturns and financial setbacks may affect their prices more negatively, and their trading market may be more limited.

Federated Investment Management Company