This commentary is written by Martin Fridson, a high-yield market veteran who is chief investment officer of Lehmann Livian Fridson Advisors LLC, as well as a contributing analyst to S&P Global Market Intelligence.
The high-yield index reached three noteworthy milestones in August, as measured by the ICE BofA US High Yield Index:
- Total return turned positive for the year. The index’s year-to-date total return through Aug. 31 came in at 0.75%. It was the first time the index’s 2020 return was in the black as of month-end since Jan. 31, when the YTD figure stood at 0.004%. In-between, the YTD return bottomed out at -13.12%, as of March 31.
- The index’s price climbed above 100, meaning that the average high-yield bond was priced above face value. The index first reached par on Aug. 7, at 100.01, then fluctuated above and below that threshold before ending the month at 100.70. Prior to the just-completed month the index had languished at a discount since Feb. 25, 2020, when it stood at 100.13. The interim low was 78.61 on March 23, 2020.
- The index’s spread-versus-Treasuries dropped below +500 bps. Although the ICE BofA US High Yield Index’s option-adjusted spread (OAS) ended August at +502 bps, it dipped below half the +1,000 bps distressed cutoff for one day, Aug. 27, at +498 bps. That was the first OAS posting below +500 bps since the +475 bps on March 4. In the intervening months, the spread maxed out at +1,087 bps on March 23.
Here is a striking fact about the high-yield market’s rebounds to these symbolically important levels: They occurred in the context of extremely tight credit conditions, which normally clobber speculative-grade bond prices. The Federal Reserve’s latest quarterly survey of senior loan officers found that 71.3% of banks are tightening credit standards for large- and medium-sized companies. Zero percent are easing standards, for a difference of 71.3 percentage points.
Over the past quarter-century there have been only six other months in which that differential has exceeded 60 percentage points. In none of those months did the ICE BofA US High Yield Index’s price exceed 63.95. The low was 56.58 in November 2008, during the Great Recession. In those same six months the high-yield spread ranged from +1,617 to +1,988 bps.
These historical numbers contrast rather starkly with August’s 100-plus price and sub-500 spread. The explanation seems clear: By intervening on an unprecedented scale, the Federal Reserve is supporting high-yield bond prices at a level that otherwise would be unimaginable in a recession, with commercial bankers wary of extending credit to all but the safest business borrowers. In particular, the central bank’s announced willingness to buy corporate bonds, including some rated less than investment-grade, has emboldened investors to pay prices they would not dream of absent that extraordinary support.
As a final observation about valuations, we note that on Aug. 31 the distress ratio (percentage of issues in the ICE BofA US High Yield Index with option-adjusted spreads of +1,000 bps or more) hit an all-time low for a recessionary month, at 11.58%. The previous low was 15.74% in May 2008, while the record high for the series was set in November 2008 at 84.00%.
Research assistance by Lu Jiang and Zhiyuan Mei.
ICE BofA Index System data is used by permission. Copyright © 2020 ICE Data Services. The use of the above in no way implies that ICE Data Services or any of its affiliates endorses the views or interpretation or the use of such information or acts as any endorsement of Lehmann, Livian, Fridson Advisors, LLC's use of such information. The information is provided "as is," and none of ICE Data Services or any of its affiliates warrants the accuracy or completeness of the information.