High yield spreads have tightened considerably since October 2023 and remain near the lowest levels since the Global Financial Crisis.
Narrow high yield spreads are just another sign of the current bullish environment. The S&P 500 has gained nearly 30% since the end of October 2023 to all-time highs. The concerns that kept investors up at night in 2023 — recession fears, stubborn inflation, and geopolitical instability — have given way to optimism about the strength of the US economy, the potential trajectory of interest rate cuts and the transformative potential of AI.
The rally in high yield since late 2023 – the ICE BofA US High Yield Index (the “Index”) has gained 10.85% since November 1, 2023 - also reflects technical factors specific to the US high yield market. High yield bond ETFs have experienced significant inflows, creating a surge in demand that the supply of new bonds has been unable to meet. Additionally, pension funds can now better meet return hurdles with exposure to the high yield bond market without taking additional risk in equities.
Figure 1: Spread to Worst
Index: ICE BofA US High Yield Index
As of June 30, 2024
Source: ICE Data
Figure 2: Leverage Ratio
Data as of March 31, 2024
Source: JP Morgan
From a fundamental perspective, 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).
Similarly, 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, $1.4 in high yield bonds have been upgraded1. Although this ratio has decreased significantly from its peak in 2021, it indicates that overall credit trends continue to be strong.
Beneath the surface, however, there is a stark difference in credit trends between CCC issuers and the rest of the high yield market. As of June 30, 2024, the number of CCC issuers downgraded (33) has been larger than the number upgraded (28). On the other hand, both BB and B issuers have continued to more frequently experience upgrades than downgrades. BB and B issuers have seen 138 upgrades in 2024 versus 104 downgrades.1
Overall yields are attractive relative to historical levels given the rise in rates. Starting yields (currently 7.9% as of June 30) 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%, 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.
1 Source: JP Morgan as of June 30, 2024
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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.
SOURCE INFORMATION
ICE Data Indices, LLC (“ICE Data”), is used with permission. ICE® is a registered trademark of ICE Data or its affiliates, and BofA® is a registered trademark of Bank of America Corporation licensed by Bank of America Corporation and its affiliates (“BofA”) and may not be used without BofA’s prior written approval. ICE Data, its affiliates and their respective third-party suppliers disclaim any and all warranties and representations, express and/or implied, including any warranties of merchantability or fitness for a particular purpose or use, including the indices, index data and any data included in, related to, or derived therefrom. Neither ice data, its affiliates nor their respective third-party suppliers shall be subject to any damages or liability with respect to the adequacy, accuracy, timeliness or completeness of the indices or the index data or any component thereof, and the indices and index data and all components thereof are provided on an “as is” basis and your use is at your own risk. ICE Data, its affiliates and their respective third-party suppliers do not sponsor, endorse, or recommend MacKay Shields LLC, or any of its products or services.
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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