High yield's strong start to 2019
Senior Portfolio Manager and Head of High Yield Bond Group Mark Durbiano discusses the factors that have contributed to this year’s turnaround in the high-yield bond market.
Published March 24 2019
Views as of 3-24-2019 and are subject to change based on market conditions and other factors.
Hi, I'm Mark Durbiano and I am a Senior Vice-President and head of the High Yield Bond Group at Federated Investors.
What factors have contributed to this year's turnaround in the high-yield bond market?
The high-yield market has gotten off to a good start here in 2019 and that's really directly related to the weakness we saw in the market at the end of 2018. For example, the spread between high-yield bonds and comparable treasuries bottomed in early October of 2018 at about 350 basis points and by the end of the year it'd widened all the way out to 575 basis points. We thought that created very attractive valuations as you came into 2019. Now that weakness at the end of 2018 was related to a couple of specific factors really uncertainties that existed in the marketplace. You had the government shutdown, you had trade uncertainties, you had falling oil prices, you had a lot of uncertainties about the Federal Reserve's interest rate policies. And as we've entered 2019, some of those uncertainties have gone away. Government shutdown ended, oil prices have rebounded and the Fed became much more dovish on it's interest rate outlook. And this gave the high-yield market a lot of support to move higher especially given the constructive economic conditions in the US as well as the specific company earnings fundamentals that we're seeing play out in 2019.
Where are you finding investment opportunities?
So there are a couple sectors that we really like as we move into 2019 here. One of the sectors we have a pretty nice overweight in is the packaging sector. Now this is a sector we always have liked because of the very stable demand characteristics in the business. Now those companies got hit a little bit in 2018 from rising raw material costs as well as rising logistics costs. Now typically the packaging companies can pass those costs through to their customers but it tends to be on a three to six month lag period. So as we get into 2019, those price increases are starting to take hold and in fact that lag is starting to work for them as some of those prices have actually gone down now and they're benefiting from raising prices. So it's a sector we like a lot. It tends to be very stable, the companies generate a lot of free cash flow and they can use that to service their debt. Another sector we like quite a bit is the insurance broker segment. Now these aren't the insurance companies which have exposure to floods and tornadoes and hurricanes it's the brokers that are selling commercial insurance policies to large corporations. Now typically when you go into recession those corporations still have to buy insurance so they continue to see very stable performance even when you get into a down economic cycle. Also, it tends to be a low CapEx business. So essentially what you're talking about is people in offices with computers and not working in big plants. So you have low CapEx needs therefore the free cash flow you generate or the cash flow you generate can be used to service debt as opposed to invest in plants and equipment. Another sector that we're overweight which is somewhat controversial is the pharmaceutical segment. And we have a couple investments in specific companies in the pharmaceutical segment as well as the contract research organization segment of the marketplace. And we think the specific companies we're invested in are poised to deliver pretty good performance here in 2019. Now the sector is controversial, you'll have a lot of headline risk but we think that's affected the valuation of the securities and it's caused the bonds to be very attractively priced in the marketplace.
Views are as of March 24, 2019, 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. 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. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. Federated Investment Management Company 19-10057 (4/19)