High Yield: Finding Value in a Landscape Rife with Risk
The fallout from the coronavirus is already causing economic deterioration, and will likely continue to weigh heavily on consumer sentiment as countries across the globe adapt to the new reality of travel bans, closed schools and working from home. High yield has felt the full effects of this in recent weeks, as bond and loan spreads have widened past levels experienced during the European sovereign debt crisis (2011), the commodity crisis (2016) and the volatile period in the fourth quarter of 2018. While spreads today aren’t quite at the wides seen during the global financial crisis, the trajectory and pace at which asset prices have moved in recent weeks is certainly reminiscent of that period.
Also evocative of the financial crisis, the selloff we’ve seen recently is less a result of changes to the underlying credit fundamentals of corporate issuers, at this time, than of an exogenous or unforeseen shock—in 2008, the bankruptcy of Lehman Brothers; today, the global pandemic. While we would expect fundamentals to deteriorate, particularly in more vulnerable sectors, spreads in high yield today—anywhere from 600 to 1,300 bps over the base rate—may be overcompensating for the real risk to corporate earnings.
Indeed, while defaults are likely to rise, particularly in more troubled sectors, we think they will remain largely manageable and in easily identifiable areas. With regard to corporate earnings, we expect a majority of issuers may be poised for a relatively sharp recovery from the pandemic itself, once supply lines open back up and companies return to more recognizably normal trading. We believe investors will act rationally to bridge the extreme nature of the event, providing liquidity support where necessary to help companies through the disruption. In addition, many of the companies in this space have positioned their maturity walls well following the high levels of recent refinancing activity. This, together with the low base rate environment, should help mitigate the impact of subsequent economic weakness.