2020 High Yield Review and 2021 Outlook
- 2020 provided another year of bifurcation in leveraged credit markets, stoked by pandemic-induced volatility that is rarely seen.
- I am cautiously optimistic about the year ahead, and I view 2021 as a transitional year for markets and the economy.
2020 HIGH YIELD BOND AND LEVERAGED LOAN REVIEW
The current yield is sometimes quoted as a decent approximation for what an investor in the high yield market could expect for a return over the coming year. On December 31, 2019, the current yield for the high yield market, as measured by the ICE BofA U.S. High Yield Index, was 6.30%.1 As luck would have it, the full year return for 2020 was 6.17%, and while not exactly equal to the current yield measured the year prior, it was nevertheless very close. However, as the saying goes, there are no straight lines in nature or in markets, and investors had to endure quite a bit of volatility this year to capture that yield, as reflected in Exhibit 1 below.
One can debate the natural order of markets, but in my opinion, markets are most often dictated by human nature, especially in a crisis. In March, investor’s “animal spirits” were on full display during the onset of the world-wide pandemic when high yield bond spreads widened by 730 basis points (“bps”) during the 24 trading sessions ending on March 23rd. This period included five of the ten worst days of performance in the high yield market dating back to 1997, culminating in Q1 being the second worst quarter of performance in the high yield market’s history. However, this freefall was halted by a combination of significant fiscal stimulus together with the U.S. Federal Reserve's (the "Fed") full support of credit markets, which provided a lifeline for companies and renewed confidence in investors to extend credit.
With that backdrop in mind, it should come as no surprise that primary market activity in 2020 for the high yield market was one for the record books. During the year, a total of $449.9 billion of high yield bonds were priced, smashing the previous record of $398.5 billion set in 2013. As one would expect, companies took advantage of wide-open capital markets to refinance existing debt, as two-thirds of all primary market activity was used for this purpose.
Furthermore, accommodative capital markets, as well as the extraordinary fiscal and monetary measures, without question resulted in a more muted default environment than one would have expected. This last point is especially true considering the significant increase in the number of fallen angels and the overall pace of downgrades early in the crisis. That said, according to data from J.P. Morgan, as of December 31, 2020, the trailing twelve month default rate was 6.2%. Although this default rate is more than twice the average experienced during the past five years, it still failed to hit the double-digit default rate predicted by many prognosticators, and that typically occurs in a recessionary environment. It is also important to note that the re-financing wave that took place in 2020 has lengthened the maturity profile of the high yield market, which should help reduce the number of large-scale defaults in the near-term. Of course, there remains a great deal of market uncertainty heading into 2021, and as a result, an extended period of above-average default activity is certainly not out of the question.
Nevertheless, after generating a year-to-date loss of -20.56% through March 23rd, from that point through the end of October the high yield market gained 26.10% and stood essentially flat for the year on All Hallows Eve. While markets reacted favorably following election day to the seemingly high likelihood for a divided government, it was the positive vaccine news that propelled the high yield market into year end. For context, from October 31st through year end, high yield bonds gained a whopping 5.99%.
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