Here’s a chart that should give you pause:
This is how we summed the situation up on Thursday in response to some suggestions that perhaps the US high yield market is somehow going to avert being dragged kicking and screaming into a default cycle by the beleaguered energy complex:
“Remember that time someone said ‘I want to own junk bonds right as we head into a default cycle?’ No? Neither do we. That’s because no one sane has ever said that.”
Can we say with certainty that this cycle will replicate history? Similarly, can we be sure that we haven’t already seen peak defaults? No, we can’t. There are no certainties – especially when it comes to capital markets.
What we do know however, is that four issuers defaulted this week alone, bringing the total to 100 YTD globally. That’s up a staggering 50% from last year.
But here’s the thing: it’s hard to keep a good rally down. Especially when money managers are struggling to generate alpha and thus are forced to chase the very market moves they’re supposed to be outperforming.
Case in point: we just witnessed the largest inflow into HY funds in recorded history at $2.6 billion. Translation: Risk. On. Man.
That’s not the scary part. Consider this, out from Goldman today:
“HY bond market has also digested the recent decline in oil prices. Since its local highs on June 8, WTI has declined by 11.5%; yet HY bonds have returned +2.3% and spreads compressed by 24bp over the same period. This divergence is reflected in the declining sensitivity to oil as shown in Exhibit 3. Unlike past iterations when the HY/oil correlation decline coincided with higher crude prices, the recent episode of oil/credit decoupling was accompanied by a drop in crude, normally a driver of re-coupling. Within the HY market, the bifurcation between commodity-related sectors and the rest of the market has also substantially abated shown in Exhibit 4. The differential between HY and HY ex-Energy and Metals and Mining spreads has collapsed to 21bp from a peak of 157bp in mid-February. This suggests that macro has taken back the driver’s seat for risk appetite after oil relinquished its heavy grip on the HY market from June 2014 to February 2016.”
(Charts: Goldman; our highlight)
Now first of all, any time you see the phrase “this time is different” it should immediately trigger your “red-flag-o-meter.” Basically what those charts are telling you is, i) HY is no longer correlated with crude prices, and ii) that the market is pricing in less and less of a difference between HY energy/ HY metals and mining and HY as a whole.
Obviously, that’s absurd. Here’s a chart worth considering when you think about the viability of these apparent market “signals”:
Note the grey shaded area. That’s basically HY energy default risk minus HY default risk ex-energy. What that suggests is that the risk in HY energy is now the lowest it’s been since late 2014 relative to HY as a whole with energy names excluded.
So here’s your Friday challenge: spot the disparity between what that chart is telling you and what the first chart in this piece seems to suggest, bearing in mind that most of the defaults in HY have been commodities related.
