The Poor Visibility of High-Yield Investors
The stock market's crystal ball has been clearer than the bond market's recently.
Risk-averse bond investors are usually the first to be on the lookout for any whiff of trouble. But this year, stock market investors have been sounding the alarm on struggling companies and hitting the exits, with the bond investors, particularly those in high-yield debt, sticking around to ask the questions.
Consider J.C. Penney Company Inc. In early January, the struggling retailer announced that its holiday sales had been lackluster. Stock investors saw the writing on the wall, predicting correctly that there would more trouble ahead, and the retailer's shares tumbled to $6.76. Indeed, J.C. Penney's bottom line is on track to drop by two-thirds this year. Its stock has since sunk to just more than $3.
J.C. Penney's bonds, though, including one that doesn't mature until 2097, have mostly held their value until just recently. A 2037 J.C. Penney bond with a B rating that started the year trading at 85 cents on the dollar was still trading at 79 cents in mid-August. It has since sunk to 63 cents. And the bond market seems to have hope for that 100-year bond, and I guess the idea that J.C. Penney, or physical retailers at all for that matter, will be around in 2097. It's trading at 59 cents on the dollar.
The shares of Avon Products Inc., too, had a big slump in February after the company announced that its lifeblood, the ranks of sales representatives, was shrinking, hurting sales. The cosmetic company's 2023 bonds, though, traded near par value as recently as May. The debt, which carries a B rating, has since slipped recently to 77 cents on the dollar.
The delayed, or lack of, reaction by the bond market to borrowers' woes has some worried that there's something out of whack with high-yield debt. "When a stock falls 50 percent or 60 percent in most environments, the bond market will not ignore that signal because the same types of things that drove the stock down should drive the debt lower," hedge fund manager Boaz Weinstein said at an investing conference in September. "The credit market doesn't seem to care anymore."
High-yield debt investors could probably be forgiven for their willing blindspot. In their hunt for anything resembling yield in a world where that has been hard to find, investors have accepted less and less premium compared with investment-grade debt. Junk bonds are yielding about 2.5 percentage points more than investment grade corporate bonds, which is narrow, but they have traded at lower spreads before -- remember 1.5 percentage points in 2007 and 1998? -- which has convinced some that the market isn't overheated, at least not dangerously so.
But high-yield debt investors may finally be waking up to the danger. Last week, concern that a tax deal would not include a corporate tax cut until 2019 showed up in the high-yield market. Junk bond prices dropped just more than 1 percent in the first half of the week, and investors withdrew cash from junk-bond funds at the fastest pace in eight weeks. Stocks barely budged before falling nearly half a percentage point on Thursday and Friday.
High-yield investors may finally be taking the blinders off for good. They may be shocked to discover things that stock investors would consider old news.
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