In our recent blog post, Energy is lagging, but consumers are set to spend, we emphasized the bifurcation of the US high yield market between weaker commodity-specific sectors and stronger consumer-oriented sectors. This theme continues to play out broadly. However, September showed that another US high yield sector — not linked to commodities — has joined in the weakness: technology, media and telecommunications (TMT). This is important because TMT and commodity-related sectors together comprise almost half of the overall US high yield market.1 Therefore, we believe it is important to evaluate the US high yield landscape and reiterate why we think there is currently value in US high yield.
What’s behind the TMT decline?
In September, the only sectors that performed worse than the broader Barclays US Corporate High Yield Index were commodity and TMT-related (see chart below).1 While key commodity-related sectors (energy and metals and mining) remain weak mainly due to global trade pressures emanating from China, TMT weakness has been due to credit-specific events, in our view. Both media and telecom have been under pressure due to heavy new issuance and the recent downgrade of a major telecom issuer. Because telecom and media comprise a significant proportion of the US high yield index, weakness in this sector has certainly negatively affected overall high yield spreads.1
Examining the bigger picture in high yield
More broadly, the ambiguity around the next Federal Reserve move has led many market participants to question the strength of the US economic engine, which has weighed on US high yield bond prices. September represented the fourth consecutive month of negative total high yield returns, something we haven’t seen in two decades.1 However, while risk markets may need to adjust to a lower growth environment, our base case remains that US fundamentals remain in good shape outside of commodity-oriented sectors. We believe the overall high yield market has been painted with too negative a brush; current spread levels imply a default rate well above what we would reasonably expect over the next two years, even accounting for continued weakness in commodities.
We believe recent spread widening in US high yield presents compelling value for careful investors. With a yield of around 8% on the Barclays US Corporate High Yield Index (as of Sept. 30, 2015), there are potentially some bargains to be found, in our view.1 We believe a rigorous credit selection process is imperative, certainly in the energy and metals and mining sectors. While some recent new issuance has put pressure on the US high yield market, we believe the market will find stronger footing in the fourth quarter as earnings and economic data confirm US fundamentals against a backdrop of attractive valuations.
Communications and commodities lagged the broader US high yield market in September
Total returns for each sector of the Barclays US Corporate High Yield Index (%). Data from Sept. 1, 2015, to Sept. 30, 2015. The yellow bar represents the returns for the full index.
1 Source: Barclays US Corporate High Yield Index, as of Sept. 30, 2015.
The Barclays US Corporate High Yield Index is an unmanaged index considered representative of fixed-rate, noninvestment-grade debt.
Spread represents the difference between two values.