Junk Bonds Are Winning Even When They’re Losing
(Bloomberg Opinion) -- Sometimes, figuring out why the stock market rose or fell on a given day feels like nothing more than a crapshoot. One day (really, many days), it’s “U.S. Stocks Rally Amid Trade Talk.” Then, days later, they drop because the top U.S. trade negotiator dialed back expectations. My personal favorite explanation, amid five straight days of losses in the S&P 500 Index last week: “U.S. stocks edged lower as investors struggled to find inspiration after a torrid start to the year.”
Junk bonds, too, are coming off a rough week. The Bloomberg Barclays U.S. Corporate High Yield Total Return Index fell for four straight days, the longest losing streak of the year, with triple-C debt tumbling the most since December. In this market, though, it’s much easier to pinpoint what happened. And it seems clear that the risky securities are still largely on solid footing.
Yes, some of last week’s decline had to do with a general “risk-off” mood, given that equity and oil prices slumped. But something more mundane was afoot in the junk-bond market – a supply-demand mismatch.
Investors – perhaps wanting to lock down profits on 2019 returns in excess of 6 percent – pulled $1.9 billion of cash from high-yield funds in the week through March 6, Lipper data show. That’s the largest outflow since late December, when junk bonds were pummeled for weeks on end. These recent withdrawals coincided with a wave of borrowing. In the week ended March 1, speculative-grade companies sold $8.1 billion of debt, the most in a single week since early August. And then last week, issuers including Archrock Partners, Digicel International and Scientific Games International priced another $2.6 billion.
All things considered, the sales did well. As Bloomberg News’s Gowri Gurumurthy reported, Scientific Games had to price its $1.1 billion of debt to yield 8.25 percent, compared with talk of 7.75 percent to 8 percent. But Archrock Partners hit right on its target of 6.875 percent and Digicel locked in a yield of 8.75 percent, down from talk of 9 percent. Still ahead, as soon as this week: Power Solutions, the biggest leveraged buyout deal since September. Gurumurthy noted the $4.7 billion offering had $15 billion in orders after just two days of pitching to prospective buyers.
All these signs point to a healthy market, buoyed by a good-but-not-overheating economy that should keep default rates at bay. The meteoric rebound in the first two months of the year clearly couldn’t go on indefinitely, but with the Federal Reserve still seen as firmly on hold and 10-year Treasury yields at the lowest in two months, why shouldn’t the push into speculative grade continue? Crucially, the fixed rates on junk bonds look more appealing at this point in the tightening cycle than floating-rate leveraged loans.
Of course, longer-term risks remain. Last week’s shocking payrolls report, which showed employers only added 20,000 jobs during February, might suggest that the long-forecast economic slowdown is around the corner. Indeed, as I wrote last month, junk bonds seemed a bit too quick to rally from their putrid December, when investors lost the most in three years even though not a single speculative-grade company borrowed.
Supply, in its own way, creates confidence among bond traders. With each new deal that has too many orders, or is clinched at a lower yield than initial price talk, they get a bit more evidence that 2019’s rally isn’t just a secondary-market bubble waiting to burst. Even if it means a few down days along the way, that trade-off is worth it.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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