It seems the best way to sum up on the markets of late is with the word “volatile.” We’ve seen surprise moves on the currency and interest rate front from the likes of Switzerland and Canada and the launch of quantitative easing in Europe. Russian hostilities are once again heating up and talk of a Greek euro exit. Oil continued to hit new multi-year lows during the month. There have been many major earnings disappointments, as factors such as a strong dollar and weakening demand weigh on multinational corporations. Q4 GDP came in weaker than expected. Thus, in January, we saw the Dow Jones Industrial Average move more than 100bps on the majority of the trading days in the month and both the Dow and S&P 500 fall over 3% on the month. We’ve seen the 10-year Treasury yield fall from 2.17% to 1.68% and the 30-year Treasury yield fall from 2.75% to 2.25%, a decline of a whopping 49bps and 50bps, respectively.
While volatility is generally viewed as a negative thing in investing—in fact, risk is often measured in terms of volatility of returns—it isn’t always necessarily negative. In reality, we believe that volatility can create some compelling opportunities for investors, especially for those that are actively managing portfolios. But its nature, volatility often leads to issues in specific securities or industries causing contagion to other areas of the market. This in effect can create securities that have been hit purely by that contagion, and for no other fundamental reason.
We believe this is exactly what we are seeing right now in much of the high yield market. Some of this contagion from weakness in the energy sector and in equities has bled over into the high yield space, creating what we believe to be compelling opportunities in many non-energy related names for which we have seen no change in the fundamentals of the businesses. Many of the high yield issuers tend to be relatively small, niche, largely domestic focused companies. Thus we would expect many of them to be much less impacted by currency factors hurting large multinationals that are pervasive in investment grade corporates and the large equity indexes. While the US economy has had some hiccups, we certainly don’t expect to see a massive economic decline here.
As we look at today’s high yield investment landscape, we are excited about the current opportunities we see. Since last June, yields for high yield bonds have increased 1.79% and spreads for the high yield market versus Treasuries have increased 188bps to nearly 600bps.1 Some of this is rightfully so in the energy names (see our recent writings on our concerns for US shale issues), but there is also much of the market that has been hit for what we see as no fundamental reason. When we see prices decline and yields increase for what we view as no fundamental reason, we would view that as an attractive entry point.
To give the opportunity we currently see a little more tangibility, consider the statistics below:2