People who almost never ask about junk bonds are asking about junk bonds so Citi thinks it's time to buy

Credit strategists at Citi have a bold trade idea to start 2016: Buy junk.

In a note to clients over the weekend, Stephen Antczak and the team at Citi recommended that clients looking for a “tactical trade” take a swing at what was one of the ugliest parts of the market last year.

Behind this recommendation are basically two things. On the one hand you’ve got your standard contrarian outlook is going to say that going into a new year, buy the worst thing from the prior year. Especially when, in Citi’s view, there’s a way to look at that terribly-performing asset that doesn’t make it look quite as bad.

And on the other hand Citi has investors who are typically outside usual crop of junk bond investors interested in the space.

High-yield bonds — more commonly known as junk bonds — returned -5.6% in 2015 including the coupon (or regular interest payment, which rose to an effective yield of around 8.7% at the end of 2015). As Citi writes, this performance was “extraordinarily poor.”

Even when backing out energy junk bonds, which were by far the worst performers in the junk space, this was the fourth-worst year for junk debt since Citi began tracking this debt back in 1991.

But in Citi’s view the earnings underlying these non-energy companies that have junk debt outstanding aren’t as bad as the performance last year really warrants. So, buy them.

Citi’s second reason for buying junk is
quite interesting.

Basically, the firm’s high-yield team has been getting calls from all kinds of investors who don’t usually buy this stuff. As a result, this “incremental bid,” or change in sentiment towards junk bonds could be a catalyst for sending the sector higher.

Here’s Citi (emphasis added):

Second, and every bit as important, is that growing interest from outside the traditional HY investor base may prove to be a catalyst for a rally as we begin the new year. In recent weeks we have had a tremendous amount of inquiry about value in the HY space from various non-traditional market participants, ranging from EM portfolio managers to European stock investors to private bank clients to IG salespeople.

In our experience an unexpected incremental bid (offer) can often be the catalyst for reversals — after all, levels are extreme enough to draw their interest, in our view — and there may very well be more of an incremental bid lurking than many traditional credit investors realise at this point.

By this outline, then, it seems that everyone is starting to look around for “value” — we’re all “value investors” now — and landing on junk, one of the most hated sectors in 2015.

Of course, the contrarian contrarian might say that the “junk bond tourists” looking to buy this stuff could be the sign that the worst is in fact not over for the space.

Because, you know, if everyone knows that something is a good buy then it can’t actually be a good buy, right?

So the thinking goes, more or less. Though this contrarian wheel-spinning eventually sends you into outer space or somewhere close.

On Monday morning, however, just about everything was selling off in what looks to be an ugly start to the year for markets that just endured an unpleasant 2015.

For the bold investor willing to hold their nose, Citi has at least one idea.

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