High yield PMs sharpen pencils for 2019 as selloff highlights risks around growth, trade, oil
High yield investors are becoming pickier as a looming recession, global trade tensions and falling oil prices continue to weigh on high yield spreads despite historically low year-end supply. Increased dispersion between credits is set to be a defining theme for 2019, 10 buysiders told Debtwire.
After a sustained selloff in the third quarter that shuttered primary markets early, bonds in the ICE BofAML HY index are now spread across a wider range of yields, with substantially more names trading in the teens compared to the end of the third quarter.
One portfolio manager likened it to the final weeks of 2014, when high yield investors rushed to rebalance their portfolios amid a burgeoning crisis among energy issuers: “It’s the same playbook. Guys have got to sharpen their pencils again.”
Just USD 4.95bn in of US high yield bonds pricing since 1 November—down 88% from the same time period last year, when USD 40.3bn of new deals were closed, according to Debtwire data. Issuance had already dropped off a cliff by the time Mercer International priced the last new deal of the year.
This lack of new supply has done little to support secondary trading, however, with the ICE BofAML high yield index widening 124bps to an effective yield of 7.42% since the beginning of October, as investors fret over lower economic growth projections, plunging oil prices and global geopolitical tension.
Markets plummeted again on Wednesday and Thursday after the Fed raised interest rates by another 25bps and signalled more hikes in 2019. But economic fundamentals are broadly judged to be relatively strong, making investors are reluctant to pull too much cash out of the market.
That makes individual credit analysis of paramount important going into 2019, said a trader: “If you’re trying to keep up with any benchmark, you’ve got to make your bets. It’s going to come down to credit selection and avoiding landmines.”
(Source: ICE BofAML HY Master index)
In a market where sentiment can shift rapidly and take a whole sector down or up with it, the fundamental credit-by-credit analysis becomes even more important, leading toward an emphasis on higher-rated credits and shorter-dated maturities, sources said.
But the selloff has also led to a “shoot first, ask questions later” mentality for selling on the first hint of negative news.
“The market has just been so punishing to any kind of downside negative news or perception that selling on the first down-trade has probably saved you further pain in the following days, weeks, months,” the trader said.
The volatility has also crimped liquidity, meaning investors have had to re-evaluate the extent of their conviction around credits, particularly among smaller names.
“Names that might have had some yield and might be good performers and smaller, we have to have much more conviction in those names because flows have been atrocious,” they said.
Break the cycle
Growing concerns that the next recession may come sooner than previously expected have pushed investors towards higher-rated names in less cyclical sectors. Investors broadly highlighted healthcare, telecoms and media as slightly lower risk sectors going into a downturn.
“Industries that have recurring revenue streams such as certain segments in media, certain segments in telecom, and healthcare names will be fine,” said another portfolio manager.
While markets fell this week after the Fed raised rates, higher-quality bellwether names in these sectors have substantially outperformed during the selloff.
Centene’s Ba1/BB+ USD 1.2bn 4.75% senior unsecured notes due 2025 traded today at 95.25 to yield 5.687%, compared to 99.875 to yield 4.772% on 1 October, according to MarketAxess. That 91bps widening compares to an average widening of 139bps for healthcare names.
T-Mobile’s Ba2/BB+ USD 2bn 6.5% senior unsecured notes due 2026 traded today at 103.035 to yield 5.798%, down from 105.625 to yield 5.207% on 1 October—a 59bps move, compared to an average widening of 130bps for the telecoms sector.
On the other end of the spectrum, investors are deserting issuers that are seen as more at risk from an economic downturn, such as homebuilders and rental equipment.
Homebuilder Tri Pointe’s Ba3/BB- USD 300m 5.25% senior notes due 2027 are trading at 80 to yield 8.6%, down from 90.125 and 6.77% on 1 October.
United Rentals’ Ba3/BB USD 750m 4.625% senior unsecured notes due 2025 are at 88.25 to yield 6.8%, down from 97.57 for a 5.039% yield on 2 October.
(Source: ICE BofAML HY Master index)
While global trade tensions—particularly between the US and China—have been on investors’ minds throughout 2018, the recent selloff has sharpened investors’ focus on how companies are adapting to tariffs and their impact on earnings, sources said.
Issuers in the industrials, metals and mining and auto sectors have already been hit by higher raw material costs, putting pressure on their margins. A breakthrough in talks between China and the US earlier this month appeared to give some reprieve but the outlook is still uncertain.
“A lot of these companies are already expecting troughs in their cycles in 2019 and then on the other end they’ll get squeezed by the increased costs for their material inputs, lowering their margins, if not eliminating them,” said one of the portfolio managers.
AK Steel’s B3/B- USD 400m 7% senior notes due 2027 last traded at 82 to yield 10.284% on 11 December, trading down roughly 15 points from trades in the 97 context for a 7.443% yield at the beginning of October.
Manufacturer Apex Tool Group’s Caa1/B- USD 325m 9% senior notes due 2023 traded at 88 to yield 12.799% on 13 December, down from 97.5 for a 9.71% yield at the beginning of October.
Several automotive names have also declined, amid concerns over tariffs. Jaguar Land Rover’s Ba3/BB- USD 500m 4.5% senior notes due 2027 traded at 74 to yield 8.812% on 17 December, up from a low of 72.501 and 9.105% on 7 December but still down from 81.75 and 7.3% before the selloff.
Auto parts manufacturer Tenneco’s B2/BB- USD 500m 5% senior unsecured notes due 2026 last traded on 14 December at 80.875 to yield 8.471%, down from 90.75 yielding 6.534% at the start of October.
“We’re wary of the auto sector and companies supplying parts to GM and Ford,” said a portfolio manager. “Anybody susceptible to tariff issues that has raw materials sourced from China is going to hurt.”
Over recent months, US auto dealers have also grown more pessimistic in their expectations for sales, according to data from the 4Q18 Cox Automotive Dealer Sentiment Index (CADSI), which surveys a sample of US auto dealers on current and expected auto retail sales.
Dealer sentiment for the fourth quarter declined to 44 from 57 in 3Q18 and is expected to tick up only slightly in 1Q19 to 49, according to the CADSI.
In a reflection of the risks of a recession as opposed to trade war pressures, the dealers attributed their deflated positivity to “rising interest rates and stretched consumer incomes,” according to a Cox Auto press release.
Oil be damned
Meanwhile, sources are divided over how to react to volatility in the energy sector, with some looking at the recent selloff as a buying opportunity and others treating it as a warning of more pain to come.
WTI and Brent crude hit respective highs of USD 76.41 and USD 86.29 per barrel on 3 October, but have dropped to USD 46.24 and USD 54.89 over concerns around supply.
Some investors see the drop in oil prices as temporary and expect a rebound in the latter half of 2019. “They just need to stick it out until then, and the higher quality names can do that,” said another portfolio manager.
Others were inclined to stay away from the sector entirely. “It’s hard to not be invested given the size of the industry through the index, but it is becoming less and less attractive to us as an investable industry,” said a trader.
Investors pointed to 3.7x-levered Chesapeake Energy and 5x-levered California Resources as examples of both ends of this spectrum.
Chesapeake’s B3/B- USD 1.3bn 8% senior unsecured notes due 2027 traded at 85.5 to yield 10.638% this week, down 17 points from 102.623 to yield 7.492% on 1 October.
California Resources’ Caa2/B- USD 2.25bn 8% second lien notes due 2022 last traded today at 66.188 to yield 20.944%, down from 97.345 to yield 8.764% at the beginning of October, according to MarketAxess.
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