Junk Selloff Means Buy at Barclays to Citigroup: Credit Markets

The $1.4 trillion market for U.S. junk bonds is looking cheap to a growing number of investors and strategists following a selloff that pushed yields to the highest levels since November.

Barclays Plc recommends adding “exposure” to speculative-grade debt after small investors withdrew more than $20 billion from mutual funds that focus on the securities over a 25-day period ended Aug. 8. Wells Fargo & Co. calls the market a “buying opportunity,” while Citigroup Inc. says investors should be “long” the bonds.

“I would certainly rather be long than short,” Stephen Antczak, the head of U.S. credit strategy at Citigroup, said in a telephone interview. “Whether that’s scale in or flat out add risk, I would be long because it’s likely to be one of the better-performing sectors in credit over the rest of the year.”

The bullish sentiment comes after the market tumbled as much as 1.96 percent as turmoil raged from Ukraine to Gaza. Instead of marking the start of a long decline in the bonds, the bulls say the debt will gain while the economy continues to strengthen and the Federal Reserve keeps interest rates at record lows through at least mid-2015.

Junk Returns

Junk bonds have returned 147 percent since the depths of the credit crisis, according to Bank of America Merrill Lynch’s U.S. High Yield Index, allowing the neediest companies to access financing at record-low rates. The market value of bonds in the index has ballooned from $728 billion in the same period.

The latest selloff pushed yields to as high as 6.1 percent on Aug. 1 from a record low of 5.2 percent on June 23. During that period yields rose from a seven-year low of 335 basis points more than similar maturity Treasuries to 425 basis points at the start of the month, Bank of America index data show

Investors pulled a record $7.1 billion from mutual funds that buy the securities in the week ended Aug. 6, surpassing the previous peak of $4.6 billion in June 2013, according to data provider Lipper.

“The high yield outflow trend has left significant market dislocations in its wake,” Michael Kessler, a credit strategist at Barclays, wrote in yesterday’s report. It has upended “many established trading relationships and left ‘‘high-yield attractive on a relative basis. We recommend that investors add exposure to the asset class at current levels.’’

Opposite ‘Directions’

Citigroup is the second-largest underwriter of the bonds after JPMorgan Chase & Co., Bloomberg data show. Barclays is ranked eighth. JPMorgan forecasts returns of 7.5 percent this year for the debt, according to an Aug. 8 report. The bonds had gained 4.2 percent through the first seven months of the year.

Spreads may be more than 70 basis points more than their fair value, according to a Citigroup model, which uses default and liquidity risk to reach its determination. In June, when spreads reached their lowest level for the year, the bonds seemed too expensive, according to Antczak.

‘‘Spreads are going in one direction and default risk is going the other way,’’ he said. ‘‘Any time you see a disconnect between valuation and fundamentals, it’s an opportunity to add exposure.’’

U.S. gross domestic product is forecast to expand at an annualized rate of 3.10 percent this quarter and next as the labor market strengthens, according to the median estimate of about 75 economists surveyed by Bloomberg.

Default Risk

Investors are betting the economy will be strong enough for the Fed to start increasing interest rates next year. There is a 55.2 percent chance the U.S. central bank will raise rates to at least 0.25 percent by March 2015, based on fed funds futures.

A measure of the risk of default on high-yield debt for one year, which the New York-based Citigroup measures in basis points, has dropped 5 basis points to 50 basis points in the last month and a half.

The default rate for speculative-grade corporate debt may rise to 2.7 percent by next June, compared with 1.5 percent in the same month this year, Diane Vazza, Standard & Poor’s head of global fixed income research, wrote in an Aug. 12 report. The forecast is below the long-term average rate of 4.4 percent.

The recent selloff has left the high-yield market attractive, Margaret Patel, who manages about $1 billion in assets at Wells Capital Management, said in an interview.

Last week’s outflows followed a 1.3 percent loss for the debt, the first monthly decline since August 2013, Bank of America Merrill Lynch index data show.

Not everybody is willing to wade back in to the assets.

‘Healthy’ Correction

‘‘It will be a buying opportunity at some point, just not sure we’re done correcting yet,” said Scott Colyer, chief executive officer of Monument, Colorado-based Advisors Asset Management Inc., which oversees about $14 billion. “High yield has been a one-way trade for so long, corrections like this are healthy.”

The move in the market is warranted amid risks such as increased geopolitical concerns, James Keenan, head of Americas credit at BlackRock Inc., the world’s biggest money manager, said in an interview yesterday on Bloomberg television.

Issuance of $2 billion is the slowest start to the month in three years, after more than $227 billion of speculative-grade rated bonds were sold through July, Bloomberg data show.

‘Encouraging’ Signs

JPMorgan strategists point to signs that some investors are plotting their return to the market.

“We do find it encouraging buyers are already stepping in, particularly in the face of improving relative value amidst a lack of fundamental erosion,” they wrote on Aug. 8.

High-yield bonds may return to previous valuations and remain among the best performing fixed-income sectors, Brian Rehling, the chief fixed-income strategist at Wells Fargo Advisors, wrote in an Aug. 12 report.

David Breazzano of DDJ Capital Management LLC, is seeing signs of that demand.

“There’s definitely a bid out there,” Breazzano, who manages $8 billion in high-yield bonds and loans as DDJ Capital’s chief investment officer, said in a telephone interview. “There was no fundamental change to the market. No market continually appreciates month after month except for Bernie Madoff’s.”

To contact the reporters on this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net; Matt Robinson in New York at mrobinson55@bloomberg.net

To contact the editors responsible for this story: Shannon D. Harrington at sharrington6@bloomberg.net Faris Khan

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