The high-yield bond market has been “extremely overvalued” for a record nine consecutive months, according to Martin Fridson, a money manager at Lehmann, Livian, Fridson Advisors LLC.
The streak breaks the previous record of eight months set in October 2006 to May 2007, Fridson wrote in a report being published by S&P’s Capital IQ Leveraged Commentary & Data. Fridson, who had been the top-ranked high-yield analyst for nine straight years in an Institutional Investor poll, considers high-yield debt to be extremely overvalued when option-adjusted spreads are one standard deviation below his estimated fair value price.
Bond investors have been forced to seek riskier assets amid record-low interest rates from the U.S. central bank, pushing spreads on junk bonds to about the lowest level since 2007. Yields on debt rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P have declined to 5.96 percent, below the 10-year average of 8.91 percent, according to the Bank of America Merrill Lynch U.S. High Yield Index.
“The pressure to find yield is causing investors to rationalize investing in paper that is subject to major price risk,” said Fridson, who started his career as a corporate-debt trader in 1976. “This has to be a concern to those who believe, as I do, that the market distortions of 2007 aggravated the subsequent dislocations experienced in 2008.”
After the previous streak ended in May 2007, spreads more than doubled in the next five months amid a credit market seizure, leading to a negative total return of 2.8 percent, Fridson said in the report.
With record-low yields, investors in speculative bonds have to settle for relative value, currently available with CCC rated debt, compared with other grades, Fridson said. Buyers may also want to consider debt of energy and financial issuers over traditional defensive industries such as cable and health care, Fridson said.