The crazy world of high-yield debt is enjoying a huge resurgence in 2016, after collapsing late last year.
Now another bank has weighed in to show that the worst is over for people involved in high yield investment, with investor appetite for risk recovering.
In its latest weekly “High Yield Flow Report”, Bank of America Merrill Lynch analysts, led by Michael Contopolous, show that high-yield debt in the USA has seen its fifth consecutive week of inflows, gaining more than $11 billion (£7.6 billion). The market has now had its biggest ever inflow over a four week period.
Here’s what BAML had to say (emphasis ours):
US HY recorded another impressive +$2.01bn (+1.0%) net inflow last week, their 5th consecutive time in the green. Over the last 4 weeks, US HY has gained a net $11.52bn from retail flows, the largest ever in a 4 week span for the asset class. Given the 40% increase in WTI prices since February 11th, improving economic data, and dovish support from the ECB, it is not surprising to us that retail has piled into risk assets and by extension US HY lately.
And here’s the chart:
High-yield debt is all about greater risk and greater reward, with the chances of defaults way bigger but the amount of money to be made sky high. High-yield debt is anything issued by companies given a credit rating of BBB- or below by credit-rating agencies.
It’s the risky end of the debt market as it is more volatile than safer debt such as government bonds, but it has become popular because it offers high returns in an era of near-zero and sub-zero interest rates.
At the end of 2015, several investment funds focused on the high-yield market imploded, causing a wave of panic. In December, the US fund Third Avenue said it would liquidate its Focused Credit fund and freeze withdrawals because it was unable to sell its high-yield bonds fast enough.
In the same month, Lucidus Capital Partners liquidated its entire portfolio to return the $900 million (£623.2 million) it had under management to investors.
Those collapses brought out the most pessimistic people in the markets, many of whom forecast doom. Societe Generale’s notorious uber-bear Albert Edwards predicted that the high-yield crisis would spread into stocks, and that S&P 500 could crash 75%. He also predicted a new global collapse at a conference in London.
So far, that hasn’t materialised, and markets have rallied. The S&P is even within 5% of its all-time high. That’s sent investors flocking back into riskier assets, as BAML’s chart’s show.
Despite the resurgence in the high-yield markets, BAML urged caution, saying that the recent inflows to the markets have been an “overreaction”. Here’s the bank once again (emphasis ours):
However, given that the fundamental backdrop has not changed and defaults are in fact increasing, we believe these inflows are an over-reaction to transitory tailwinds. In fact, we think the recent rally has limited staying power as yesterday’s acknowledgement by Chair Yellen of stresses in financial markets, combined with a weaker consumer and poor Q4 earnings season should have created renewed fears of a growth slowdown in the US, in our view.
High-yield may be popular again, but investors need to be careful.