High yield spreads have tightened considerably over the past several quarters. As of March 31, 2024, the BofA ICE US High Yield Index’s (the “Index”) spread-to-worst was 332bps, significantly lower than the 20-year median of 454bps and at the low end of the post-GFC* general “non-panic range” of 350-550 bps.
Figure 1:
Index: ICE BofA US High Yield Index
As of March 31, 2024
Source: ICE Data
Tighter spreads are logical in the context of the "everything rally" market environment. Recently the S&P 500 Index, Bitcoin, and Gold have reached all-time highs, corresponding to a robust appetite among investors for fixed income. Since November 2023, the US high yield market has seen significant inflows, creating a demand that the supply of new bonds has been unable to meet. This imbalance has contributed to a further tightening of spreads. It appears that some pension investors are shifting from stocks to high yield bonds to secure their equity gains while still seeking some excess return.
From a fundamental perspective, the credit trends within the US high yield bond market remain stable. The leverage level of high yield issuers is near historical lows, according to JP Morgan (Figure 2).
Figure 2:
Source: JP Morgan
Similarly, as illustrated in Figure 3, the "upgrade-to-downgrade" ratio in the high yield bond market is above one, meaning that for every $1.0 of high yield bonds downgraded by credit rating agencies, $1.2 in high yield bonds have been upgraded. Although this ratio has decreased significantly from its peak in 2021, it indicates that overall credit trends continue to be strong.
Figure 3: Last 12 Months of US High Yield Upgrade to Downgrade Ratio (by Par)
Data as of December 31, 2023
Source: JP Morgan
Beneath the surface, however, there is a stark difference in credit trends between CCC issuers and the rest of the high yield market. So far in 2024, the number of CCC issuers downgraded (23) has been significantly larger than the number upgraded (11). On the other hand, both BB and B issuers have continued to more frequently experience upgrades than downgrades. BB and B issuers have seen 66 upgrades in 2024 versus 40 downgrades. (source JP Morgan)
Overall yields are attractive relative to historical levels given the rise in rates. Starting yields (currently 8.0% as of April 10) have generally been good indicators for subsequent 5-year performance for the market. Moreover, US High Yield looks attractive relative to equities, with the spread between the yield on the Index and the earnings yield of the S&P 500 Index at 4.0% (as of March 31, 2024). US High Yield has also performed well relative to equities in past cycles when starting yields have been near current levels.
There are many risks in financial markets today. However, we maintain that stable fundamentals and reasonable valuations suggest that US high yield continues to represent a reasonable, lower duration fixed income investment option.
*Global Financial Crisis of 2008
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High yield securities have speculative characteristics and present a greater risk of loss than higher quality debt securities. These securities can also be subject to greater price volatility.
use of issuer names
All security, issuer and company names cited herein are done so for informational purposes only. The securities, issuers and companies cited herein are only intended to convey factual information and current market conditions. Such names are not intended, nor should they be construed as, a recommendation to buy and sell any individual security nor as an indication of current or future profitability. Issuers cited herein do not necessarily represent portfolio positions of MacKay Shields or its affiliates, nor does MacKay Shields express any views, positive or negative, on such issuers.
SOURCE INFORMATION
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CREDIT RATING DISCLOSURES (FOR INDEX)
ICE BofA Credit Ratings
ICE BofA utilizes its own composite scale, similar to those of Moody’s, S&P and Fitch, when publishing a composite rating on an index constituent (eg. BBB3, BBB2, BBB1). Index constituent composite ratings are the simple averages of numerical equivalent values of the ratings from Moody’s, S&P and Fitch. If only two of the designated agencies rate a bond, the composite rating is based on an average of the two. Likewise, if only one of the designated agencies rates a bond, the composite rating is based on that one rating.
COMPARISONS TO AN INDEX
Comparisons to a financial index are provided for illustrative purposes only. Comparisons to an index are subject to limitations because portfolio holdings, volatility and other portfolio characteristics may differ materially from the index. Unlike an index, individual portfolios are actively managed and may also include derivatives. There is no guarantee that any of the securities in an index are contained in any managed portfolio. The performance of an index may assume reinvestment of dividends and income, or follow other index-specific methodologies and criteria, but does not reflect the impact of fees, applicable taxes or trading costs which, unlike an index, may reduce the returns of a managed portfolio. Investors cannot invest in an index. Because of these differences, the performance of an index should not be relied upon as an accurate measure of comparison.
The following indices may be referred to in this document:
ICE BofA US High Yield Index
The ICE BofA US High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. The ICE BofA US High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch) and an investment grade rated country of risk (based on an average of Moody’s, S&P and Fitch foreign currency long term sovereign debt ratings). In addition, qualifying securities must have at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of $100 million. Original issue zero coupon bonds, "global" securities (debt issued simultaneously in the Eurobond and U. S. domestic bond markets), 144a securities and pay-in-kind securities, including toggle notes, qualify for inclusion in the Index. Callable perpetual securities qualify provided they are at least one year from the first call date. Fixed-to-floating rate securities also qualify provided they are callable within the fixed rate period and are at least one year from the last call prior to the date the bond transitions from a fixed to a floating rate security. DRD-eligible and defaulted securities are excluded from the Index.
S&P 500 Index
The S&P 500 Index is an unmanaged index that is widely regarded as the standard for measuring large-cap US stock market performance.
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