Selloff Is Coming For U.S. Junk Bonds, Wellington’s Goodman Says

(Bloomberg) -- It makes sense to be ready for a selloff in U.S. junk bonds now, even if the timing of any market drop is unclear, said Campe Goodman, a fixed-income portfolio manager at Wellington Management Co. in Boston. 

Goodman, who oversees a portfolio of about $44 billion of multi-sector fixed income strategies, spoke with Bloomberg’s Gowri Gurumurthy on Sept. 30. Comments have been edited and condensed. 

What’s your outlook now for the U.S. high-yield market?  

It’s priced for all good news, leaving very little room for capital appreciation. There’s nothing that has started to turn negative yet, but it is a good idea to lighten up on exposure when you are not getting paid enough for risk. By the time we see it, it will be too late. The market is not thinking enough about tail risk that is clearly emerging. 

Read more in this week’s Credit Brief: JPMorgan Gives In; Coming Selloff

What are some of those possible risks? 

Central banks are likely to be less accommodative over the next year. China is already tightening in different ways by cracking down on leverage. And the U.S. Federal Reserve has indicated that it will begin steadily tapering this year and end by the middle of next year. This is less accommodation, if not tightening. 

So yields can can go up and growth can slow down as the Fed becomes less and less accommodative.

Another possibility for a selloff is equity valuations. Equities have priced in robust growth in earnings. A slow down in earnings as growth slows could cause a meaningful sell off in equity markets, causing some disruption in credit markets.  

So how do you position for that? 

We’re holding cash and high-quality instruments to be ready for a selloff when that tail risk materializes and that can happen suddenly.

Things might seem quiet now but there should be plenty of opportunities to buy between January and June. U.S. junk bond yields could go up to 5%-6% by the middle of next year.

Emerging markets offer more opportunities now as U.S. high yield market valuations remain tight. And bank loans are more attractive than straight high yield debt, because they’re floating rate. 

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