TCW's Rivelle Sees More Junk Losses in Cycle's `Violent Death'

  • Years of low rates require correction `in the next recession'
  • Fund buys investment-grade bonds even as prices may drop more

Tad Rivelle, who oversees $147 billion in fixed income at TCW Group Inc., has bad news for investors in corporate bonds: the high-yield market will deteriorate further, defaults will rise significantly and a recession in the U.S. can’t be ruled out.

“Every credit cycle dies a violent death and this one will too,” Rivelle said in a webcast posted on TCW’s site this week. “We are convinced of that.”

Rivelle, 54, who helps run the $71.6 billion Metropolitan West Total Return Bond Fund, said he was buying investment-grade bonds even though their prices could fall further. TCW prefers what he calls “bendable assets,” which are likely to eventually rebound in price, and is avoiding “breakable assets,” or parts of the high-yield market where prices may never recover.

Junk bonds are mired in their deepest slump since the 2008 financial crisis, hurt by plunging commodity prices and fears that an economic slowdown in China will crimp growth in the U.S. High-yield bonds have declined 3.9 percent this year following a drop of 4.6 percent in 2015, according to a Bank of America Merrill Lynch index.

DoubleLine Capital founder Jeffrey Gundlach, who in early 2015 foresaw tough times coming for high yield, said the bonds may be headed for a steeper selloff. “We could be looking at a really ugly situation in the first quarter of 2016,” Gundlach told investors during a Jan. 12 webcast. “I’m not yet a buyer.”

Strong Performance

Gene Neavin, co-manager of the top-rated $732 million Federated High Yield Trust, is more sanguine. Outside of the energy and commodity industries, “fundamentals are fine, credit quality is fine and defaults will be very low,” he said in an interview last month. Neavin said the asset class could produce mid to high single-digit returns in 2016.

Rivelle’s MetWest Total Return beat 96 percent of peers over the past five years, according to data compiled by Bloomberg, and this year it gained 1.6 percent through Feb. 8, better than 81 percent of competitors. 

The fund has about 2 percent of its assets in high-yield bonds. Government bonds represented 35 percent of assets and mortgages accounted for 32 percent as of Dec. 31, according to TCW’s website.

Rivelle, in the webcast and a follow-up telephone interview, painted a generally bearish picture of credit markets, saying excesses have built up with help from years of ultra-low interest rates.

“Low rates created a lot of the problems that will have to be fixed in the next recession,” Rivelle said in the interview.

‘Waves’ Coming

He said he’s skeptical that the Federal Reserve or other central banks will be able to stop the damage because tightening financial conditions -- the higher interest rates companies now have to pay to borrow money -- will more than offset the helpful impact of any future actions by policy makers.

Bryan Whalen, also a manager on the Total Return fund, said on the webcast that default rates in the U.S. high-yield market will move from the current 2 percent to 3 percent range to at least 5 percent to 7 percent and possibly higher, and that the failures would come in industries outside energy and commodities.

“The bankruptcies and restructuring will come in waves and we haven’t seen the waves hit,” Rivelle said in the interview.

‘Base Case’

He called a U.S. recession “a reasonable base case,” without necessarily predicting that the economy would slip that far.

“When capital markets become hostile to risk-taking that is typically the condition that causes recessions,” Rivelle said.

Economists surveyed by Bloomberg expect the U.S. economy to expand 2.4 percent this year.

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