Are Widening Spreads Within the High-Yield Bond Market Alarming?

High-yield corporate bonds have had an impressive performance so far this year, with the Bloomberg Barclays High Yield Bond Index returning 5.5% year to date on the heels of a strong 17% return in 2016. Month to date, however, the index has returned -0.6%, with much of the weakness attributed to lower rated Caa bonds, which make up approximately 15% of the index (Ba rated bonds make up another 44%, B rated bonds make up 39%, and the remaining 2% or so are below Caa or non-rated).

Option-Adjusted Spreads (OAS) represent the difference between the index yield and the yield of a comparable maturity Treasury. The OAS can be used to measure the risk levels markets are placing on high-yield bonds.  As spreads widen, investors demand a higher yield relative to lower-risk Treasuries, meaning risk levels have increased. To put it another way, when OAS increase, the prices of high-yield bonds fall (assuming there is no move in Treasury yields) as investors price in greater risk by demanding a higher yield. The chart below shows that Caa spreads, which track the most speculative bonds, have widened much more than the higher-quality spreads shown in blue and green. From August 8 to today, Caa spreads are wider by 0.51%, while Ba and B spreads are wider by just 0.29% and 0.21%, respectively.

It is too early to tell if this signals weakness across the entire high-yield sector, but if lower credit quality companies and their associated bonds keep getting weaker, this might indicate that the impressive run for high-yield bonds is slowly coming to an end. We will keep you informed as we evaluate any new developments.

 

IMPORTANT DISCLOSURES

Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.

The economic forecasts set forth in the presentation may not develop as predicted.

The BAA spread refers to the yield on corporate bonds above the rate on comparable maturity Treasury debt, and is a market-based estimate of the amount of fear in the bond market. BAA-rated bonds are the lowest quality bonds still considered investment-grade, rather than high-yield. Therefore, they best reflect the stresses across the quality spectrum. A rise in BAA spreads acts as a negative for the CCI.

The Bloomberg Barclays High-Yield Bond Index is an unmanaged index of corporate bonds rated below investment grade by Moody’s, S&P or Fitch Investor Service. The index also includes bonds not rated by the ratings agencies.

This research material has been prepared by LPL Financial LLC.

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