Junk Bonds Whipsawed With Biggest Gains in 18 Months
Junk bonds, which posted the worst loss in almost two years in June, are now staging a comeback with the biggest gain in 18 months.
Dollar-denominated speculative-grade notes have returned 2.4 percent in July, following a 2.6 percent decline in June and pushing this year’s advance to 3.9 percent, according to Bank of America Merrill Lynch U.S. High Yield index. Clear Channel Communications Inc.’s $7.7 billion of bonds in the index have surged 9.1 percent since plunging 10.9 percent from May 22 to June 24, the data show. Steelmaker ArcelorMittal’s $14.1 billion of notes are up 4.8 percent after dropping 7.6.
Buyers are clamoring for yields that reached the highest levels since November after Fed Chairman Ben S. Bernanke pledged this week to “maintain a high degree of monetary accommodation” when the central bank’s debt-purchasing slows. The two biggest exchange-traded funds that focus on high-yield debt have reported about $687 million of deposits this month after investors yanked about $1.8 billion in June, data compiled by Bloomberg show.
“Yields became attractive enough that people started to come back into the market,” said Marc Gross, a money manager at RS Investments in New York who oversees about $3.5 billion in fixed-income funds. “It’s been a pretty impressive rally.”
Bernanke is lulling bond buyers back into speculative-grade securities by assuring them that no course has been set for paring stimulus that has pumped $2.6 trillion into the financial system since the collapse of Lehman Brothers Holdings Inc. in 2008. The Fed chairman helped trigger the selloff after telling Congress on May 22 that sustainable labor-market progress could prompt policy makers to scale back $85 billion of monthly bond purchases in their next few meetings.
That sent yields on 10-year U.S. Treasuries (USGG10YR) surging, reaching as high as 2.75 percent on July 8 from this year’s low of 1.61 percent on May 1.
Junk-bond yields climbed to as high as 7.15 percent on June 25 from 6.04 on May 22 before dropping back to 6.51 percent as of yesterday, Bank of America Merrill Lynch index data show. The extra yield investors demand to own the debt instead of similar-maturity Treasuries widened as much as 107 basis points during the period to 534 basis points on June 24, before recouping more than half of the loss in less than three weeks.
The swing in high-yield bond returns since the end of May is the biggest since the notes posted a 2.21 percent loss in November 2011 following a 5.96 percent monthly gain, the index data show.
The securities, which have posted an average annual return of 19.8 percent since the end of 2008, are returning 6.5 percentage points more than investment-grade debt in 2013, with Bank of America Corp. (BAC) strategists predicting the higher-risk notes will continue to outperform through year-end.
The $21.4 billion of HCA Holdings Inc. bonds in Bank of America Merrill Lynch’s junk index have climbed an average 5.1 percent since June 24 after the debt of the nation’s largest for-profit hospital chain declined 6.5 percent in the five weeks following Bernanke’s May 22 comments.
“We did view the selloff as a buying opportunity,” said Eric Takaha, director of the corporate and high-yield group at Franklin Templeton Investments in San Mateo, California. “We were buyers particularly of high yield after the dip in some of our multi-sector fixed-income accounts.”
Elsewhere in credit markets, the cost to protect against losses on corporate bonds in the U.S. fell for a third day to an eight-week low. Investors added $1.8 billion this week into funds that purchase leveraged loans in the U.S., an all-time high, according to Bank of America.
The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, declined 0.8 basis point to a mid-price of 73.8 basis points as of 12:37 p.m. in New York, the least since May 23, according to prices compiled by Bloomberg.
The indexes typically fall as investor confidence improves and rise as it deteriorates. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Bonds of New York-based Time Warner Cable Inc. (TWC) are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 4 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Time Warner Cable’s $1 billion of 4 percent notes due in September 2021 dropped the most since they were issued in 2011 after Bloomberg News reported that Charter Communications Inc., backed by billionaire John Malone, is working with Goldman Sachs Group Inc. to pursue a bid for the pay-TV system. The notes fell 3.2 cents to 92.9 cents on the dollar to yield 5.07 percent, Trace data show.
The loan-fund increase brought deposits this year to about $38 billion, an almost 50 percent rise in assets, Charlotte, North Carolina-based Bank of America said in a report yesterday. U.S. speculative-grade bond funds reported an inflow of $2.8 billion, the most since October 2011.
Funds that invest in senior-ranking bank debt have gained every single week this year, returning 3.1 percent, Standard & Poor’s/LSTA index data show. Prices on the largest, first lien floating-rate borrowings rose to 98.26 cents on the dollar, the most since May 31.
Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.
July gains in junk bonds are the most since the debt returned 2.9 percent in January 2012, Bank of America Merrill Lynch index data show. Even with June’s loss, the 3.9 percent return this year compares with a 2013 decline of 2.6 percent for investment-grade bonds in the U.S. Yields on the notes have dropped to 6.51 percent, or 53 basis points above the all-time low reached May 9, after rising to 7.15 percent on June 25.
“Many overreacted in the short term,” said David Breazzano, president of DDJ Capital Management LLC, which oversees more than $6 billion in assets ranked below investment grade. “High yield is relatively attractive as a fixed-income investment.”
The trailing 12-month global speculative-grade default rate fell to 2.8 percent at the end of the second quarter from 3.1 percent in the same period last year, according to Moody’s. In the U.S., the high-yield default rate dropped to 2.9 percent from 3.3 percent a year earlier.
Investors have been pushed into the higher-risk assets as the Fed, along with its debt purchases, holds benchmark borrowing costs at about zero for a fifth year. The central bank is seeking to ignite economic growth and reduce a U.S. unemployment rate that swelled to as high as 10 percent in October 2009. The jobless rate has since shrunk to 7.6 percent through June. Yields on 10-year Treasuries ended yesterday at 2.53 percent, up from 1.76 percent at year-end.
“A rising interest-rate environment due to an improving economy is very bullish for high-yield credit spreads,” Bank of America credit strategist Hans Mikkelsen wrote in a July 17 report. “When the risk of further rapid increases in interest rates declines, as we have seen post-payrolls, high-yield total returns can quickly recover and attract inflows.”
Investor demand this month spurred the creation of 6.2 million of new shares, or about $569 million, in BlackRock Inc.’s $14.7 billion iShares iBoxx $ High Yield Corporate Bond ETF, the biggest of its kind, Bloomberg data show.
State Street Corp.’s $9.7 billion SPDR Barclays High Yield Bond ETF (JNK), the second-biggest, has reported about 3 million shares created since June. That’s equal to about $119 million. About $1.8 billion of shares were yanked from the two funds in June.
“ETFs are a significant factor for the high-yield market,” DDJ Capital’s Breazzano said. “Ten years ago that wasn’t the case. When you get emotional retail investors making some dramatic changes, it can create some short-term volatility.”
The price of Clear Channel’s $1.75 billion of 9 percent bonds due in March 2021 rose to 101 cents on the dollar yesterday from as low as 92.5 cents on June 24, Trace data show. The yield fell to 8.8 percent from 10.4 percent. ArcelorMittal’s $1.1 billion of 6.25 percent notes have risen to 105.25 cents from 100.25 cents on June 24, with the yield falling to 6 percent from 6.7 percent.
“Even following the better performance in July, we still think valuations are reasonable,” Franklin’s Takaha said. “You can see these technicals occur again and again, and if you have a longer-term investment horizon, you can look to take advantage of them.”
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