Tire Plunge Shows `No Margin for Error' in U.S. Junk Bond Market

(Bloomberg) -- Investors got schooled on the dangers lurking in a high-yield market priced for perfection last week as bonds issued by American Tire Distributors Inc. plunged into the abyss.

Reports that one of its major customers, Goodyear Tire & Rubber Co., planned to drop the independent supplier of tires spurred a violent selloff as S&P Global Ratings downgraded to CCC+ from B-.

As a result, the benchmark $975 million bond due 2022 tumbled to as low as 40 cents on the dollar Wednesday, according to Trace data. It traded as rich as 102.25 cents as early as April 16.

Tire Plunge Shows `No Margin for Error' in U.S. Junk Bond Market

To Peter Tchir, head of macro strategy at Academy Securities Inc., the saga evokes memories of Toys ‘R’ Us Inc. last September, when investors were caught off guard by the collapse in the retailer’s debt.

The roller coaster in notes issued by American Tire Distributors underscores how there’s "no margin for error in an illiquid" market for low-grade bonds, he wrote in a Sunday note.

"That sort of price action scares me as it does show the market can have prices very wrong," he said. "This is not the sort of environment that 5 percent or so compensates you for."

While the selloff was driven by company-specific factors and the tire distributor says it’s seeking to develop new business, there’s growing angst toward the asset class. Interest-rate risks loom large, while premiums over Treasuries at the index level remain not far off pre-crisis lows.

As such, Tchir favors lower-duration assets like Treasury bills and floating-rate notes.

"I don’t see how the asset class formerly known as ‘high’ yield offers enough value to justify the risk in the current environment."

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