Chart of the Week: High Yield Default Rates
The current environment is beginning to inspire a number of comparisons to the last credit cycle (along with some very painful memories). Investors would be well served to heed the advice recently provided by Oaktree’s Howard Marks, (who’s stock coincidentally hit new all-time highs this week). Mr. Mark’s Word of Wisdom was simply, Ditto.
While we agree on most points, we do continue to see value in “off-the-run” high yield bonds. According to our friends at Grant’s, the gap between big and small issues in the high yield market has rarely been wider than it is today. Consequently, this is the sand box we choose to put our shovels to work in. And since our shovels are quite a bit smaller and quicker than the large institutional mutual funds in the markets, we are still able to construct an attractively valued and high yielding portfolio with little interest rate risk today. Guggenheim Partners CIO, Scott Minerd, provided us with a nice picture of this dynamic in his last weekly:
“Despite a temporary spike in 2005, the U.S. high-yield bond default rate has, historically, tracked the federal funds target rate closely, with a lag of approximately two years. Given the Federal Reserve’s efforts to maintain a low interest rate environment for an extended period of time, high-yield default rates should remain depressed, which is supportive of credit spreads.”
I’m not so sure it is quite that simple. For example, Japanese rates have been pegged at zero for nearly a generation, yet the economy has seen more than their fair share of defaults. That being said, this just reinforces the need for good balance sheet analysis and diligent credit work to separate the men from the boys. We’ll put our “Bond Guy” up against any of those boys.