Clouds Build Over Junk Rally JPMorgan Says Has Topped Out

  • Several companies forced to scrap or alter terms on bond sales
  • JPMorgan Asset Management cuts high-yield bond holdings

A rally that sent yields on the world’s riskiest corporate bonds to a three-year low is showing signs of faltering.

A string of companies including Virgin Media and Berry Global Group Inc. have had to scrap or alter terms on planned debt sales, the biggest exchange-traded fund tracking junk debt has suffered two consecutive months of outflows, and a gauge of high-yield energy bonds has plunged alongside last month’s drop in oil prices.

JPMorgan Chase & Co. and Seven Investment Management LLP are among those losing enthusiasm for an asset class that they say no longer offers enough reward for default probabilities amplified by the drop in oil and refinancing risk as central banks raise rates. JPMorgan Asset Management’s Absolute Return & Opportunistic Fixed-Income team has cut the share of junk debt in its $17 billion portfolio to about 40 percent from more than half.

“Everything looks a bit overbought and is susceptible to a wobble,” said Ben Kumar, a money manager in London at Seven Investment, which oversees about 10 billion pounds ($13 billion). “It doesn’t take much to start the sort of spiral of panic we saw in early 2016.”

More than $1.8 billion has drained out of BlackRock Inc.’s iShares iBoxx High-Yield Corporate Bond ETF in the past two months in part due to oil’s plunge into a bear market, which hurt energy companies that make up 13 percent of the junk-bond index. The extra burden on company revenues comes just as borrowing costs may be set to rise. Central bankers in Europe, England, the U.S. and Canada all signaled in the past week that they are moving toward policy tightening.

“We are more likely to decrease risk rather than increase risk due to valuations,” according to Daniel Goldberg, a portfolio manager at JPMorgan in New York. “We still believe that fundamentals are solid though technicals have reversed somewhat.”

As the market reassesses junk-debt risk, at least three issuers in the U.S had to drop borrowing plans, while the German maker of packaging materials, Kloeckner Pentaplast GmbH, boosted the proposed yield on a loan and Italian services company Manutencoop Facility Management SpA bowed to buyside demands for improved terms. 

Pushback

The pushback is a healthy sign of investor resolve, albeit one that’s under threat, according to Olivier Monnoyeur, a London-based high-yield portfolio manager at BNP Paribas Asset Management, which has 580 billion euros ($660 billion) in assets.

“Investor tolerance is every day being tested,” Monnoyeur said. “The lower the yield environment, the more difficult it will be for the investor community to maintain that discipline.”

Deutsche Bank AG strategists including Oleg Malentyev recommended selling high-yield energy bonds in a research note last week, warning that a drop in WTI crude futures to $35 a barrel would be a tipping point for contagion into the broader junk-bond market. West Texas Intermediate traded as low as $42 a barrel on June 21 before recovering to $46.58 a barrel Monday as industry data pointed to easing supply.

Yields on the Bloomberg Barclays Global High Yield Index advanced 14 basis points to 5.32 percent last month, but are still trading within 40 basis points of a record low touched in June 2014. For Seven Investment’s Kumar, yields at these levels indicate that sentiment is close to a turnaround.

“There’s no immediate reason it should crash, but it just strikes us as if it’s priced as if we shouldn’t worry about anything ever again,” Kumar said. “That’s a dangerous place to be in risk assets.”

— With assistance by Lisa Pham

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