Junk Bond Rebound? Wall Street Titans at Odds Over Answer

The woes in the junk-bond market are getting opposing interpretations from Goldman Sachs Group Inc. and AllianceBernstein LP.

To Goldman analysts, the underperformance doesn’t make a lot of sense and could end soon because the U.S. economy’s growing and the debt is still benefiting from central-bank stimulus. AllianceBernstein, on the other hand, is cautioning investors against seeing recent price declines as a clear-cut buying opportunity given defaults will probably rise.

“We think stretching for yield at this point in the cycle is risky,” Ashish Shah, director of global credit at AllianceBernstein, wrote in a Nov. 10 note. “We doubt the returns over the next 12 months will justify the risk.”

Yields on U.S. high-yield securities have widened almost a percentage point relative to government bonds in the last five months on concern that the market’s gotten frothy and global growth is slowing. The debt is on track for its worst three-year return versus U.S. stocks since 2000, and is also lagging behind higher-rated corporate notes this year.

Junk bonds have returned 4.7 percent in 2014, versus a 6.7 percent gain for investment-grade securities, according to Bank of America Merrill Lynch index data. The Standard & Poor’s 500 Index has handed investors 12.2 percent.

Yield Starvation

Goldman says high-yield traders are being too negative on the economic outlook as U.S. unemployment plunges to the lowest since 2008.

“Even if global slowdown risk were to materialize, it would be extremely unusual to end up in a recessionary environment while so many central banks are providing so much monetary accommodation,” Goldman Sachs analyst Charles Himmelberg wrote in a note today. “With fixed-income markets still starved for yield, we do not think the high-yield market will remain out in the cold for long.”

The sell-off has been overblown because a relatively-low volatility environment will likely persist as central banks maintain stimulus programs, according to Himmelberg. The Federal Reserve has held its benchmark interest rate near zero for almost six years.

“We see no reason why credit risk appetite shouldn’t recover,” Himmelberg wrote.

Oil Prices

Junk bonds have disproportionately suffered from falling oil prices because more than 15 percent of speculative-grade securities are tied to energy companies, while such borrowers account for only 9.7 percent of the S&P 500, according to Goldman Sachs.

AllianceBernstein argues that the high-yield rout does have something to do with the fundamentals. The lowest-rated junk bonds have plunged 4.4 percent since the end of June as oil prices dropped, raising doubts about the profitability of energy companies that have sold a record volume of speculative-grade bonds.

“In this case, we view the sell-off as more warning siren than opportunity,” wrote Shah. “Remember, CCC-rated bonds are issued by fragile companies with high leverage and weak balance sheets. It doesn’t take much for such companies to fail.”

(For more Market Line insights, see NI MKTLINE.)
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