Not only has the high yield market posted an average return of 13.6% in the 15 calendar years during which we saw rates rise over the annual period since 1980, but it has had only one down year over this time frame. Rates generally go up during periods of economic growth which is generally favorable for corporate credit. So what happens if we are wrong and the economy strengthens significantly, and rates along with it? Well history would indicate high yield investors are in one of the better asset classes for that scenario.
The Federal Reserve may start raising rates this year or next to get the ball rolling, and may move rates up a quarter of a point a few times over the next year, but we expect their move to be fairly minimal and largely be irrelevant for the high yield market. We may even see the financial markets move up on an actual rate move as it removes the uncertainty. For all of the talk of a hit to high yield, we don’t expect a moderate rate move to have a meaningful impact. For rates to really accelerate, we need to see much stronger global growth, which again would be a positive for corporate credit in terms of lowering the already low default rate risk as income and cash flow improved.
Anyone who is avoiding the high yield asset class due to a potential rate increase or waiting until we see what the Fed does, or even attempting to time a bottom, is missing what we see as a great opportunity to generate yield. With many now expecting that we don’t see a rate move until March of 2016, almost six months away, and a high yield index now yielding around 8%5, you would miss about 4% of income, irrespective of any pricing upside, by sitting on the sidelines waiting for a tiny 25 bps move by the Fed.
We believe the rising rate concerns for the high yield market are overblown by the financial media and that the current spread levels offered by the space are well compensating investors for this uncertainty. For those sitting on the sidelines “waiting and seeing,” you may well miss the very attractive, tangible yield we see currently offered by the high yield debt market. For more on our thoughts about rates and the value in today’s high yield market, see our piece “Making Sense of Markets.”
1 Data as of 10/29/15, sourced from Bloomberg.
2 Daily Treasury Yield Curve Rate, source U.S. Department of Treasury, for the period 6/30/15 to 9/30/15.’
3 Daily Treasury Yield Curve Rate, source U.S. Department of Treasury, for 10/28/15.
4 High yield and investment grade data sourced from: Acciavatti, Peter Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “2008 High Yield-Annual Review,” J.P. Morgan North American High Yield Research, December 2008, p. 113; “High-Yield Market Monitor,” J.P. Morgan, January 5, 2015, p. 3; and “2014 High-Yield Annual Review,” J.P. Morgan, December 29, 2014, p. 292. Treasury data sourced from Bloomberg (US Generic Govt 5 Yr). The J.P. Morgan High Yield bond index is designed to mirror the investible universe of US dollar high-yield corporate debt market, including domestic and international issues. The J.P. Morgan Investment Grade Corporate bond index represents the investment grade US dollar denominated corporate bond market, focusing on bullet maturities paying a non-zero coupon. S&P 500 data sourced from Bloomberg. Barclays Municipal Bond Index covers the long-term, tax-exempt bond market (source Barclays Capital).
5 Acciavatti, Peter Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “Credit Strategy Weekly Update,” J.P. Morgan North American High Yield Research, October 2, 2015, p. 29.