- Chesapeake Energy, Men's Wearhouse, Scientific Games hit
- The dealers are saying, ‘I don’t own it; I don’t care’
The morning after cancer-center firm 21st Century Oncology Inc. cut its earnings forecast for 2015 last week, money manager Rajay Bagaria woke up to find his holdings of the junk-rated company’s bonds had lost 19 percent of their market value overnight.
Investors who own Chesapeake Energy Corp.’s $11.3 billion of bonds watched about a third of their value disappear over the past three weeks. Similar free-falls have appeared on the computer screens of traders in debt of retailer Men’s Wearhouse Inc., gambling-equipment maker Scientific Games Corp. and the owner of New York Sports Club. By one measure tracked by Deutsche Bank AG analysts, the debt of the riskiest companies is selling off at four times the rate of the least-risky junk borrowers -- a ratio that’s typically 1.6 times.
Investors in the debt of junk-rated companies are showing little patience for even the slightest whiff of bad news as they seek to shield themselves from the market’s first annual loss since 2008. With the Federal Reserve poised to lift interest rates next month and a deepening commodities slump stirring fears that earnings growth will be squeezed, price swings in the market are intensifying. To Wasserstein & Co.’s Bagaria, it’s creating a combustible environment that’s starting to remind him of the last credit crisis.
"It almost feels like 2008 a little bit,” said Bagaria. "When companies underperform, the amount their debt can trade off is much greater than ever before. And then there’s the fear of illiquidity."
Investors are shunning the lowest-rated junk bonds. That is underscored by the extra yield that investors are demanding to hold CCC rated credits relative to those rated BB. This has jumped to the most in six years.
With confidence slipping in the strength of the global economy, there are fewer investors to take the opposite side of a trade in the riskiest parts of the market, according to Oleg Melentyev, the head of U.S. credit strategy at Deutsche Bank.
"These are all small dominoes in one corner of the market," Melentyev said. "In the early stage, all of this looks random when there is no underlying news to support the big moves. But eventually a narrative emerges -- maybe we have turned the corner on the credit cycle.”
The price swings are being exacerbated by some other factors as well. After six years of easy-money policies from the Federal Reserve, investors chasing evaporating yields have crowded into many of the same trades. And Wall Street banks have pulled back from their traditional role as market markers amid tougher post-crisis regulations.
21st Century was punished after lowering its earnings guidance to between $155 million and $160 million after previously forecasting as much as $190 million. The next day, dealers were quoting prices for the CCC rated bonds that were 20 cents lower. By week’s end, the debt, sold at par in April, was down 17.75 cents to 78 cents on the dollar. Gambling equipment maker Scientific Games posted sales that missed analysts’ estimates. Chesapeake has been ravaged by plunging commodity prices and Men’s Wearhouse lowered its outlook for same-store sales for the fourth quarter.
U.S. high-yield bonds have lost more than 2.5 percent this month, with bonds rated CCC and lower sliding 4.6 percent, Bank of America Merrill Lynch index data show. A loss in November would make it five declines out of six months for the index.
That the selloff in the debt has been more pronounced than traders might expect is indicative of a more discerning market, said Niklas Nordenfelt, a money manager at Wells Capital Management.
"Normally you don’t see this kind of differentiation until you are in a much more precarious environment," Nordenfelt said. "In previous periods, you would have the entire market sell off in one fell swoop. This suggests we could have a prolonged period of selectivity, which is healthy."
One sometimes-overlooked element that’s contributing to the big price swings is the increasing concentration among investors, according to Stephen Antczak, head of credit strategy at Citigroup Inc. Mutual funds, insurance companies and foreign investors make up 68 percent of corporate bondholders compared with 52 percent at the end of 2007.
That means that if one mutual fund investor wants to sell some holdings, there isn’t another one that’s ready to step in. That’s because they typically have similar mandates from investors and often need to sell for the same reasons.
"A less diverse group of investors hold a lot more bonds," Antczak said. "The difference between incremental buyer is more now than it used to be. It takes a bigger move to get people interested."
Bonds of smaller companies that carry a high amount of debt relative to earnings are most susceptible to falling quickly after earnings are reported, said Michael Carley, a co-founder of hedge-fund firm Lutetium Capital.
Money managers looking at the bonds of those types of companies aren’t spending time examining the issues in those businesses before selling because they’ve got their “own wounds to lick,” said Carley, the former co-head of distressed debt at UBS AG. “And the dealers are saying, ‘I don’t own it; I don’t care.’ So it just plunges.”