2019 High Yield Market Review
- In a year in which the high yield bond market produced double-digit performance, uncharacteristically lower-rated bonds lagged their higher-rated peers.
- I do not expect a recession in the coming year and generally view 2020 as having the potential to produce another year of price appreciation for the high yield market.
2019 HIGH YIELD MARKET REVIEW
In 2018, the high yield market ended the year on a low note. A negative return in December capped off one of the weakest quarters of high yield bond performance in history. Of course, this negative performance was not isolated to the high yield market. Rather, concerns surrounding trade tensions, economic growth and the trajectory of monetary policy weighed heavily on markets ranging from corporate bonds to equities. Many market observers were curious whether 2019 would bring more of the same or if markets would reverse course.
By way of background, I am by nature an optimistic person. This may seem counterintuitive given my chosen profession; after all, when it comes to investments in the high yield market, one must always be focused on what can go wrong. Having said that, I cannot help but view things through the prism of positivity. So, even in the face of dreadful performance to end 2018, I was cautiously optimistic about the prospects for the high yield market in 2019.
History shows that it is not uncommon for the high yield market to generate an above-coupon return following a year of negative performance, and as it turned out, 2019 was no exception. Consequently, while the strong performance of this past year is not a shock, what has been surprising is the way in which the double-digit gains in the high yield market were generated. From the chart below, one can observe that 2019 performance was led by BB-rated bonds, rather than CCC-rated bonds, which customarily have been the best performer within the high yield asset class in a year of double-digit gains.
Notwithstanding the outcome at year-end, an interesting but rarely highlighted point is that through April, CCC-rated bonds were outperforming their BB-rated and B-rated counterparts by 181bps and 146bps, respectively. During the first four months of 2019, declining U.S. Treasury yields, minimal supply of new bonds and an accommodative Federal Reserve led investors to view yields in the high yield market as relatively more attractive when compared to alternatives. These factors led investors to pile into high yield mutual funds, thereby bidding up high yield bond prices.
However, as summer approached, the weather heated up and so did trade tensions between the U.S. and China, resulting in a risk-off mentality that led to a divergence in the performance of CCC-rated bonds and their higher-rated peers. As a result, higher-rated bond issues (which are also typically longer duration and larger sized than most CCC-rated issues) significantly outperformed during the year.
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