Corporate credit prices firmed this week amid ongoing equity strength, solid economic data and rising U.S. Treasury yields.1,2,3 High yield bonds gained approximately 0.16% during the week ended October 5, bringing September’s returns to approximately 0.90%.4 Despite August’s modest decline, high yield bond returns were strongly positive during the third quarter, providing gains of approximately 2.04% in what was the asset class’s seventh straight quarter of positive returns.4 Energy high yield bonds were an outperformer in September, providing returns of approximately 3.4% last month after underperforming the broader benchmark index in August.5 Another outperformer was CCC rated bonds, which gained approximately 1.6% in September after underperforming their higher-rated peers in August.6 For context, CCC rated bonds are providing year-to-date returns of approximately 9.9%, outperforming both B rated bonds (6.6%) and BB rated bonds (7.0%) as investors continued to migrate down the corporate capital structure in search of yield.6,7,8 Senior secured loan prices also improved this week as bank loan mutual funds experienced their first weekly inflow in seven weeks.9,10
Weather or not
After declining to 2.06% in September, the U.S. 10-year Treasury yield rose to a five-month high this week amid a steady stream of solid economic data and rising expectations for a December rate hike.3,11 Meanwhile, the U.S. Federal Reserve’s persistent support for a third rate hike by year’s end has helped to drive the yield on the U.S. 2-year Treasury bond to its highest level since October 2008.12 Though impacted by hurricane-related disruptions, a handful of strong U.S. economic data points for September was a focus for bond investors this week. The Institute for Supply Management (ISM) manufacturing and non-manufacturing survey helped to reinforce investor optimism, with September’s manufacturing activity rising to a 13-year high and non-manufacturing activity rising to its highest level since 2005.13,14 Adding to the reflationary tone this week was speculation around the future of the leadership at the Fed.15 With President Trump signaling he will soon name a successor to Chair Yellen, any change in U.S. central-bank leadership has the potential to reshape monetary policy. Possible candidates include former Fed Governor Kevin Warsh and current Fed Governor Jerome Powell, both of whom are viewed as more hawkish than Yellen.16
Ahead of the Friday’s nonfarm payrolls report, economists were expecting a weaker headline figure in light of recent disruptions caused by hurricanes Harvey and Irma.17 Against expectations of an 80,000 gain in jobs, however, the payrolls number was worse than expected, declining by 33,000 in September. 18,17 While the drag from weather-related effects was more severe than expected, other areas of the report painted a rosier picture of the U.S. economy. At 4.2%, the unemployment rate dropped to its lowest level since 2001.18 The underemployment rate declined to 8.3% from 8.6% in August, and the labor force participation rate ticked up slightly.18 However, bond investors were primarily focused on the jump in average hourly earnings, which rose 0.45% from the month prior and 2.9% over the past 12 months.18,19 While the labor market has showed continued strength over the past few years, wage growth has been slower to materialize. While the Fed is likely to look to October’s report for confirmation of any trend, this month’s report suggests wage growth may finally be picking up.
Chart of the week: A solid fundamental backdrop
- With a return of approximately 7.0% through the first three quarters of 2017, high yield bond investors continue to enjoy a prolonged period of strong total returns.4 Credit markets have been boosted this year by stable economic conditions, an accommodative interest rate environment and rising oil prices. A solid fundamental backdrop has also helped to support high yield bond prices.
- For example, growth in earnings before interest, tax, depreciation and amortization (EBITDA) among high yield companies was up 11.1% during the second quarter of 2017.20 The figure moderated from the first quarter of this year, but both quarters have produced the strongest EBITDA growth in more than two years.21
- Year-over-year revenue growth has followed a similar pattern as EBITDA. For example, revenue growth among high yield issuers also declined in the second quarter of 2017 versus the first quarter.21 Like EBITDA, however, each of the first two quarters still saw the largest gain since the final quarter of 2014.21
- At the same time, leverage among high yield issuers declined slightly during the second quarter.21 Though it remains above its post-crisis low of approximately 3.87x during the third quarter of 2012, leverage has declined for each of the past four quarters.21
- On balance, this relatively positive fundamental backdrop has helped to bring the default rate on high yield bonds to an approximately 4-year low while prices remain at, or near, their post-crisis high.1,21
1 Federal Reserve Bank of St. Louis, http://bit.ly/2d3pN5b.
2 Reuters, http://reut.rs/2gh4VeV.
3 Federal Reserve Bank of St. Louis, http://bit.ly/29ecBfp.
4 Bank of America Merrill Lynch U.S. High Yield Master II Index.
5 Bank of America Merrill Lynch U.S. High Yield Energy Index.
6 Bank of America Merrill Lynch U.S. High Yield CCC & Lower Rated Index.
7 Bank of America Merrill Lynch U.S. High Yield B Rated Index.
8 Bank of America Merrill Lynch U.S. High Yield BB Rated Index.
9 Credit Suisse Leveraged Loan Index.
10 Thomson Reuters Lipper.
11 Bloomberg, federal funds futures based on CME data.
12 Federal Reserve Bank of St. Louis, http://bit.ly/2anGvQ0.
13 Institute for Supply Management, http://bit.ly/2u7Z6Fq.
14 Institute for Supply Management, http://bit.ly/2g2jSi6.
15 CNBC, http://cnb.cx/2z385uy.
16 The Wall Street Journal, http://on.wsj.com/2xm0Hx6.
17 The Wall Street Journal, http://on.wsj.com/2kqjOjE.
18 Bureau of Labor Statistics, http://bit.ly/2iYbHWM.
19 CNBC, http://cnb.cx/2xX4Ozn.
20 J.P. Morgan High-Yield and Leveraged Loan Morning Intelligence, as of September 26, 2017.
21 J.P. Morgan High-Yield and Leveraged Loan Morning Intelligence, as of October 5, 2017.
The Alternative Thinking Week in Review market commentary and any accompanying data (“Market Commentary”) is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The Market Commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such Market Commentary. The Market Commentary should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the Market Commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.