Guest Post: The High Yield Conundrum
Submitted by highyieldblog
The Merrill Lynch High Yield Master II Index, often used when assessing the state of the broad High Yield market, suggests that Junk bonds have returned a whooping 51% year-to-date, thereby outperforming the SPX by a cool 29%.
I am notoriously skeptical about indices (reasons include geometric returns versus dollar weighted returns, index inclusion/exclusion problem, changes in share of CCC rated paper, etc). Looking at High Yield mutual fund indices only partly solves such issues as these indices have their own flaws but f.i. Lipper's HY index ytd return was in the low 40's and thereby almost 10 percentage points (so actually 20%) lower than the Master II's.
Mid August 2008 was the time when the HY market started its bold down move of -31% in less than three months.
Since that same August 2008 the ML index recovered and has eventually returned roughly +14%, indicating that everyone in HY land should be well ahead of their high water marks (which I doubt) and have outperformed the SPX by 28% during that time.
Issuers went into this period with very high leverage and during that same period reported earnings plunged to a degree not seen seen since 1871 (by 99%, that is), with y-o-y industrial production at -10.7%, y-o-y retail sales down -5.3% and capacity utilization at 66.6%.
Defaults have so far come in somewhat below consensus expectation but some issuers just had their chance to buy some time by extending their maturity profile selling new crap debt, some did exchange offers and/or were able to raise some capital. However, things don't nearly look as good as indices may suggest in my view.
So here is my conundrum, which is actually two-fold:
1) High Yield indexes show stellar performance (even those including only investable mutual funds, such as Lipper), implying investors in HY land should be well ahead of their high water marks. Is that actually the case? And if it is not - which I assume - where has all the positive index performance come from?
2) A very serious deterioration on the operations front meets a return of some +14% for the asset class since August 08. Why is it the case? Looks like the markets are incredibly confident they can buy themselves out of the doldrums.
Not sure if these questions best be addressed by micro- or macro economists as the former seem to be mostly wrong on particular things with the later being just as wrong in general.