On Thursday, we noted that Bill Gross will do two things:
- talk about himself in the third person by asking, on behalf of you, “what does Gross do?“
- short HY because Gross “doesn’t think high-yield spreads have any more to compress”
With regard to that second point, we showed you the following chart:
Well needless to say, that took on even more significance overnight as crude briefly plunged to its lowest level since November 15, catalyzing still more carnage across the commodities complex:
For those wondering just how ludicrous HY spreads have gotten, Goldman was out Thursday evening with a bit of color and a chart which shows that “HY spreads have been wider 95% of the time in the past 7 years.”
Moving over the small hump of the French election and back to 2014 we go. Spreads have strongly tightened following the first round of the French election two weeks ago. In the HY bond market, spreads have compressed by 28bp to 379bp, move back to the 5th percentile vs. the post-crisis period—i.e., HY spreads have been wider 95% of the time in the past 7 years. So far this year, spreads have remained solidly below their 25th historical percentile (Exhibit 1). The relatively fast mean-reversion to the February tights suggests market participants are comfortable with the outcome of the second round of the French Presidential election, for which current opinion polls continue to show Mr Macron will likely become France’s next President. Last week, we tactically upgraded HY to neutral vs. IG, from underweight, reflecting declining European tail risk and overly pessimistic sentiment with regards to the US policy agenda. But strategically, we continue to prefer IG over HY, a view that is reflected in our spread forecasts for the second half of the year (Exhibit 7). In our view, the combined effect of solid above-trend growth and reduced labor market slack should over time imply a less-friendly growth, inflation, and monetary mix for HY vs. IG as the Fed eventually leans against the risk of overheating.
So basically, Goldman is telling you that they’re still constructive on HY despite spreads being in the 5th percentile post-crisis.
We simply cannot imagine it’s a good idea to stay long HY at this point and the commodities carnage just makes our bearish conviction even stronger.
On that note, we’ll leave you with another chart to ponder:
(Goldman – with our big red highlights)