Over the past couple weeks, we’ve heard several comparisons to what we are seeing today in the high yield market, to the energy-related decline we saw a couple years ago, with people questioning if this is just the beginning. We believe these situations are very different and don’t expect some hiccups in a couple industries today to lead us to a broad decline.
In the late summer and early fall of 2014, oil prices moved from highs topping $100 on WTI to prices in the $70s. On November 28, 2014, OPEC decided to not cut production in the face of this and we saw oil fall a further 10% in just that day and fall 40% over the two months following that decision.1 Energy securities, bonds and equities alike, began to get hit. For the first several months, we saw the high yield market hold in pretty well. But by the summer of 2015, that energy weakness had spread to the broader high yield market. Between the end of May 2015 through when we saw the high yield market bottom on February 11, 2016, we saw the high yield market fall almost 13% in just over nine months.2
Going into this decline in oil prices, we saw Energy as the largest industry concentration within the high yield market, at over 18% of the total high yield market. As energy prices accelerated their decline, and other commodities along with it, which were another 5% of the high yield market, people became increasingly weary of the high yield space and the selling that was at first contained to energy and commodities spread to the broader market.3
Over the past couple weeks, we have seen declines in the high yield market, again centering on a few specific industries, here namely some weak earnings in healthcare and telecom. And with that, we’ve heard numerous people compare what we are seeing now to what we saw three years ago in energy—back then it started out being contained to energy but then eventually spread to the broader market. Is this time the same, whereby we could see huge declines in the broader market because of problems in these specific sectors?
We don’t believe so. First off, the industry concentration is significantly less. Energy and commodities together were about 23% of high yield market prior to their decline, and today, we see healthcare as about 9% of the market and telecom about 4%, for a total of 13%.4 Secondly, “energy” is a more homogenous industry than healthcare in that you have a huge portion of that industry tied to the price on two commodities: oil and gas. As prices in these and other commodities precipitously declined, it impacted everyone from the producers to the servicers—the price of oil alone fell 75% from its highs.5 Additionally, defaults accelerated in these sectors, with 75% of total 2015 and 80% of total 2016 default and distressed exchange activity related to energy and other commodities.6
Yet, healthcare and telecom are MUCH more differentiated industries. Just because hospitals are seeing some pressure, it doesn’t mean that drug companies, diagnostic imaging companies, outpatient facilities, oncology companies, etc. are going to face a problem. Very different dynamics impact these various sub-segments within healthcare. Similarly with telecom, this includes software and electronics producers as well as wireline, wireless and satellite companies. And I don’t think under any imaginable scenario, the pricing these providers are getting is going to fall 75% as we saw with oil prices. We also don’t see a big spike in default risk in these industries like we certainly saw with the energy space. Yes, earnings are weaker and spreads in these credits had been very tight/yields very low, so they are adjusting to this fundamental reality. But we aren’t hearing, not do we expect to see a wave of defaults related to these issues.
The fact is that, yes, certain companies within these industries today are feeling pressure, and some of these companies are large individual issuers and well known/well covered within the high yield market, so are widely held and are garnering the headlines. But broadly speaking, these issuers are still a tiny portion of the entire market. Corporate bond prices have been moving up over the past year and a half, and spreads/yields hit a multi-year low in October, so we are seeing things adjust in certain securities and some profit taking. People are paying attention to fundamentals, which we view as a positive and we believe supports our case for active management within the high yield sector. We believe that active investing, whereby portfolio managers are paying attention to what credits are held and look for value, rather than investing in many of the overvalued or susceptible credits within the index, is essential in the high yield space.
1 Reference prices based on WTI prices, sourced from Bloomberg (CL1 COMB Comdty). Prices over $100 in July 2014 and in $70s by November 2014.
2 Returns based on the Bloomberg Barclays Capital U.S. High Yield Index, which covers the universe of fixed rate, non-investment grade debt (source Barclays Capital). Returns for the period 5/31/17 to 2/11/16.
3 Industry concentrations sourced from Acciavatti, Peter D., Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li, “High-Yield Market Monitor,” J.P. Morgan, North American High Yield and Leveraged Loan Research, July 1, 2014, p. 20.
4 Acciavatti, Peter D., Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li, “High-Yield Market Monitor,” J.P. Morgan, North American High Yield and Leveraged Loan Research November 1, 2017, p. 19.
5 Based on WTI prices, as sourced from Bloomberg, with a high of $106.91 on 6/16/14 and low of $26.21 on 2/11/16.
6 Acciavatti, Peter D., Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li, “Default Monitor,” J.P. Morgan, North American High Yield and Leveraged Loan Research, January 4, 2016, p. 4 and January 3, 2017, p. 4.