This article was written by Scott Roberts, co-head of the High Yield team for Invesco Fixed Income. He is also a senior portfolio manager on the team and has analytical responsibilities for the chemicals, energy, utility, and paper/packaging areas.
Despite concerns surrounding the potential for higher interest rates in the US, high yield bonds were one of the best-performing fixed income asset classes through the first half of 2015. Looking into the second half — when many market observers expect a rate rise to finally, officially begin — the Invesco High Yield team continues to be constructive on the asset class. That’s because rates typically rise when the economy is expanding, and high yield bonds have historically performed well in these types of environments. In addition, we see several positive signs in the valuations, fundamentals and technical factors of the high yield market.
First half of 2015: High yield bonds outperform
In the first half, high yield bonds (represented by the Barclays US Corporate High Yield 2% Issuer Capped Index) returned 2.5%, as seen in the chart below, with most of the positive performance coming in the first quarter as the high level of income offset modest price erosion in the second quarter. A number of factors impacted performance in the second quarter, including increased equity volatility, uncertainty surrounding Greece, the impact of commodity price volatility, and pressure from higher Treasury yields. During the second quarter, the yield on the 10-year US Treasury increased from 1.92% to 2.35% and the high yield asset class posted flat performance — further illustrating its durability.1
High yield bonds were one of the best performing asset classes through the first half of 2015
Second half of 2015: A constructive outlook for high yield
We continue to be constructive on the high yield bond asset class despite the possibility of increasing interest rates. That’s because high yield bonds have historically performed well in rising rate environments. Why? Rates typically rise when the economy is expanding, signaling that companies tend to have increasing earnings and can better service their debt.
Since 1987, there have been 16 quarters where yields on the five-year Treasury note rose by 70 basis points or more, as seen in the table below. During 10 of those quarters, high yield bonds demonstrated positive returns; during the six quarters where high yield bond returns were negative, the asset class rebounded the following quarter (illustrated in blue below).
High yield performance during periods of rising rates
| 3 months ending | Increase in 5-year Treasury yields (bps) | High yield bond return (%) | High yield bond return next 3 months (%) |
| May 1987 | 144 | -2.8 | 4.1 |
| May 1988 | 105 | 0.5 | 1.0 |
| March 1990 | 81 | -2.6 | 5.7 |
| March 1992 | 100 | 8.2 | 2.5 |
| April 1994 | 161 | -4.8 | 1.1 |
| November 1994 | 98 | -0.8 | 5.5 |
| April 1996 | 118 | 0.9 | 1.9 |
| February 1999 | 74 | 0.2 | 2.2 |
| January 2000 | 74 | 2.3 | -1.4 |
| January 2002 | 90 | 4.0 | 3.0 |
| August 2003 | 118 | 3.3 | 6.2 |
| June 2004 | 99 | -0.4 | 4.4 |
| May 2008 | 95 | 4.0 | -3.4 |
| June 2009 | 90 | 22.5 | 15.1 |
| December 2010 | 74 | 3.2 | 4.2 |
| July 2013 | 70 | -1.1 | 3.0 |
| Source: J.P. Morgan 2013 High Yield Annual Review. High yield bonds represented by the J.P. Morgan US High Yield Index. Past performance is no guarantee of future results. An investment cannot be made directly into an index. | |||
Recent commentary from the Federal Reserve (Fed) has indicated that there rates could possibly increase in the second half of 2015. However, the statements have also suggested that subsequent increases will be “gradual,” without any “predetermined course.” We believe it’s unlikely that the Fed will begin to raise rates without supportive economic growth. Invesco Fixed Income’s projections for US gross domestic product (GDP) growth in the next 12 months remain in the 2.7% to 3.0% range — a level where high yield bonds have historically performed well. Positive GDP growth is supportive of high yield fundamentals, and we expect defaults to remain well below the long-term average default rate of 3.9% through the middle of 2016.2
Valuations, fundamentals and technical factors look strong
Valuations. During the second quarter, a bout of volatility caused US high yield spreads to widen over US Treasuries. With a solution to the Greek economic crisis in hand, the Invesco High Yield team expects equity volatility to decrease and high yield spreads to narrow over the next few months.
Fundamentals. In addition, we believe the fundamentals of high yield issuers have been quite strong. The exceptions have been metals and mining and energy companies, in our view, and we recognize not all companies will make it through this low price environment. However, we continue to see opportunities in energy as we see value in companies with valuable assets and low leverage.
Technical factors. The new issuance calendar has been very healthy, with a high percentage of refinancing deals and relatively low leveraged buyout activity, which is positive for the market. Moreover, the high level of refinancing that we’ve witnessed during this low-interest rate environment has pushed out the maturity timeframe, which makes it more likely that default rates will remain low, in our view. We believe the high yield asset class potentially offers a high level of income with a relatively low duration — showing that fundamental drivers are heading in the right direction.