Junk Bond $15 Billion Revival Lacks Conviction Amid Oil Risk

  • Morgan Stanley says oil `running on fumes,' poised to fall
  • Not enough evidence yet for longer term confidence: AXA

Investors are skeptical about whether the best gains since at least October in junk and distressed debt across emerging markets can be sustained amid questions about the strength of the global commodity rebound.

The revival that added $15 billion to the market value of the riskiest debentures this year may be in jeopardy. Morgan Stanley strategists said on March 30 that oil prices are “running on fumes” and are poised to fall. Goldman Sachs Group Inc. and Citigroup Inc. kept their forecasts for lower iron ore prices by year-end.

The commodity market rebound “may not provide enough evidence to provide creditors with longer term confidence,” said Jim Veneau, the head of Asian fixed-income in Hong Kong at AXA Investment Managers, which oversaw the equivalent of $761 billion at the end of last year. “I’m not sure if it will look like a rally from here on out.”

Investor sentiment toward worse-rated bonds hasn’t recovered fully amid concern that the securities will be hurt by more U.S. interest-rate increases, China’s economic slowdown and a sluggish resources market. Metals and energy-related companies accounted for 19 of 36 bond defaults worldwide this year, according to Standard & Poor’s.

Morgan Stanley said oil prices are set up like they were in the second quarter of 2015. The last time they surged 25 percent from April to June, crude slumped 38 percent in the subsequent six months, according to Bloomberg-compiled data. Emerging-market junk bonds slid 3 percent in the second half of 2015 and distressed debt crashed 12 percent, Bank of America indexes show.

“We haven’t yet seen a strengthened demand that we think is needed to have a more sustainable rally” in resources, said Caroline Bain, a commodities economist in London at Capital Economics Ltd. “We do feel that the recent rally is perhaps not grounded in fundamentals.”

Notes issued by speculative-grade companies gained 4.6 percent in March, the biggest gain since April last year, while distressed debt jumped 9.2 percent, its best month since October, according to Bank of America Merrill Lynch indexes. Brazilian steelmaker Usiminas Commercial Ltd.’s 2018 notes surged 70 percent, Chinese oil company MIE Holdings Corp.’s 2019 notes gained 54 percent, and commodity trader Noble Group Ltd.’s 2018 securities returned 38 percent.

Not Bearish

On average, the risk premium over Treasuries in emerging markets narrowed to 878 basis points from 967 in March amid further monetary easing in Europe and Japan. In Asia, they narrowed by 100 basis points to 773, Bank of America indexes showed.

“The spreads in Asia are still more than 50 basis points wider than their last two-year average, so we believe they can continue to grind tighter in the near term,” said Gaurav Singhal, a credit analyst in Hong Kong at Nomura Holdings Inc. “While the operating environment for Asian high-yield corporates remains challenging, the supply and demand backdrop are supportive and valuations still reasonable. We are not in the bearish camp.”

Defaults remain a concern for investors after last year became the worst in terms of failures since 2009. Emerging-market borrowers accounted for 26 of 113 global defaults in 2015, with oil drillers and miners bearing the brunt of it, according to S&P. This year, they added five to the 36 defaults worldwide -- which in turn is already 11 more than this time last year.

Hedge Funds

Hedge funds that bet primarily on distressed debt have lost money this year through February, after posting their first annual drop since 2011, according to Eurekahedge Pte., which tracks the performance of managers.

“Higher interest rates in the U.S. and economic slowdowns in most emerging markets pose significant headwinds for these regions,” S&P said in a March 29 report. “In emerging markets, most regions are experiencing substantial stress from the continued decline in commodity prices, exchange-rate pressures from the rising dollar, tighter lending conditions, and a rising share of nonperforming loans.”

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