So as you know, high yield has staged what can only be described as one helluva rally off the deflationary doldrums of early 2016.
Specifically, the mammoth spread compression looks like this:
That should give anyone with any sense pause if for some reason you were considering getting long at what are damn near multi-year tights.
Well on Tuesday, BofAML was out with their latest “HY Wire” note which for all intents and purposes simply says this: if you’re getting in now, the best you can hope for is to not lose any money for the remainder of the year (that’s an oversimplification, but you get the gist).
There’s also a pretty remarkable chart. Have a look at this:
So that’s basically dispersion or, perhaps more accurately, “a lack thereof.” Here’s the accompanying color:
Spread dispersion across our high yield index has come down significantly relative to where it was in February of last year. For example, after sorting our index from the widest spread to the tightest spread we find that today, 50% of the market trades at an average of 560bps and 50% of the market trades at an average of just 224bps. This compares with last year, where at its peak the widest 50% of names traded at an average spread of 1,208bps compared to 343bps for the tightest 50% of names. Today’s difference of 392bps between these two respective buckets is the tightest level since October 2014 and indicative of very little idiosyncratic risk currently being priced across issuers.
Yes, “indicative of very little idiosyncratic risk currently being priced across issuers.” So what would happen if suddenly everyone started pricing in issuer-specific risk? Well, we’re glad you asked. Here’s BofAML again:
By many measures the high yield market today is more similar to the tights of 2014 than the wides of 2016. With an economy that is still stuck in neutral, however, have markets gotten ahead of themselves? Or even worse, could the business cycle revert back to late 2015/early 2016 levels, reigniting our rolling blackout scenario where individual sectors realize moments of distress, which in turn takes the overall market wider?
So that’s interesting in and of itself, but the real notable quotable (so to speak) from this note comes later when the bank outlines “2 risks to our base case and both aren’t great.” Here’s the money quote:
However, we would be remiss to not discuss some troubling macro and micro level data that give us pause to being unequivocally bullish, particularly given the data mentioned above. Consider the following: Q4 2015 and Q1 2016, in our view, was the recession that wasn’t. By nearly every measure – earnings, revenue, spreads, lending conditions and access to capital markets — the macro environment was one that was suggestive of negative GDP growth. And in fact, economic growth hovered right around 0, with 2 consecutive quarters of sub 1% reads.
The saving grace, as it turned out, was coordinated central bank action that ultimately led to 25% of global fixed income having a negative yield, oil prices that doubled, and finally, the global populist movement sweeping Donald Trump and his growth agenda into office.
However, can we be sure that anything fundamentally has changed dramatically in the last 14 months? And with central banks positioning more hawkish, the oil rally finished, and President Trump finding Washington perhaps more difficult to navigate than he had initially thought, could the economy, and by extension markets, be exposed as really having no clothes?
That speaks for itself and as such, no further comment is necessary.
