The biggest uncertainty is with the new Fed and their rate direction as Yellen and Dudley are stepping down.  Even if the long end rises, we believe the asset class to be in is high yield corporates, with their larger coupons and lower durations, see our paper “Strategies for Investing in a Rising Rate Environment.”

The focus today is on the tax bill vote and there are many different opinions on how this bill could impact the high yield market as there are potentially limitations to the deductibility of interest yet the corporate rate will be lowered, so to us this will be a company by company analysis and not an overall market call as each company is different in how they issue debt and what tax bracket they will be in per their profit generation.

So how should investors look at the high yield market today?  You need to first look at the overall economy and the health of corporate American, and then look to the industry and health of the company you are loaning money to, whether it be in the form of a bond or loan.  The high yield market is made up of companies, many of which provide essential products and services to all of us.  When there is an end to a high yield issuer it is often because the management has mismanaged their capital structure or their product or service is no longer in demand as it once was (competition or a new buggy whip replaced it).

In the current high yield market you have expensive prices on many securities, but we don’t see a broad based credit crisis emerging.  You have had money flowing into a variety of yield products because investors often want to be diversified into different asset classes.  The good and the bad of managing yield products is that money flowing in has driven up prices and thus created nice returns, but have also made many securities overvalued to their call or maturity prices or to the credit metrics, and thus they understandably correct at some point.  We believe investors need to understand that new-issue are being brought to the market each day to refinance existing debt, and this refinancing can be done at a call price which may well be below the trading pricing of the security prior to the refinancing announcement.  Thus understanding the call schedule or the ability to evaluate the prospects of a bond being tendered at a price above the call/maturity price is important.  This sort of strategic investing involves active, not passive management.

As an active manager, Peritus targets an above index coupon and yield-to-worst with their strategy and the potential for alpha generation for investors.  Yes, index/passive investing might be less expensive, but we believe that you get what you pay for over time. We believe that being in the right credits is important.  But we also believe that being invested is important as perfectly timing the market can be difficult.  If you are someone that has an expertise in timing the market, good luck as I believe it has been proven that over time the returns are less because following a correction, the snap back can be faster than the market timers emotions allow them to step back in—so they could miss the move.

Turning to the specifics for the market today, we see the high yield market lower again this morning along with equities and oil, as the money looks to be going into longer Treasuries with the 10-year down to 2.34% from 2.4% just a few days ago.  Oil is lower as there is a report that US shale will be equal in size to the Saudi’s in a few years and the IEA reporting a less bullish demand growth outlook for 2018, along with the API reporting a build in oil inventories rather than a draw down as had been expected.

Even with some pricing weakness and outflows, there were seven new-issues that priced yesterday in the high yield bond market totaling $4B.  There are ten new-issues on the forward calendar, so this does not look like an end to high yield.  Rather to us, it looks like an opportunity to add to your positions.  We are seeing some of the strategists at the banks come out with expectations that investors will to continue to seek exposure to high yield and suggests that riskier segments of the market have seen tighter risk premiums around similar points in the credit cycle in the past.

No deals priced in the high yield market yesterday as one deal was pulled because of weakness in the market, thus meaning they would have to pay more to get it done.  There are twelve new-issues on the forward calendar.  We will see what demand there is as there is still a need for yield but with some outflows happening and weakness in the secondary market, these could take a few days to get to the market.

We believe that corporate America is in good shape as witnessed by all the earnings we are seeing and by Moody’s recently reported Liquidity Stress Index and their default outlook.  We believe this recent price weakness in the high yield market is simply investors moving money around, and it will likely eventually find its way back.  We continue to see opportunity with active vehicles, as many of those are positioned with a notably higher dividend and yield than many of the index-tracking products.

Oil was higher again last week on the back of OPEC still cooperating in production curbs, while the rig count went down.  Oil is flat today with an increase in rig count in the latest release.  OPEC estimates global oil demand growth of 1.51MMb/d which is up 130kb/d from last month’s report, with China continuing to lead the growth side of the equation.²

There were nine deals for $3.4bn that priced last week while there are another dozen on the forward calendar. Some of these new-issues have weakened post trading; we believe you still must be selective and understand the indicated demand for each deal.  Moody’s expects the global speculative-grade default rate to decline to 2.1% over the next year, which we believe indicates a continued positive outlook for high yield bonds.

Many ask about our opinion on Treasury yields and where they are headed.  We continue to point to the huge demographic change in population around the world, which we believe creates headwinds against world GDP growth and inflation, and continued QE going on in many countries—all of which we believe serves to moderate rate increases.  If you go back and read past publications on our website, www.peritusasset.com, you will see at the beginning of 2016 we called for lower long-term Treasury rates, rather than a sizable move higher as many had projected. What has happened to the yield curve in 2017?

From two years to 10 years: 72 basis points, down from 125

From two years to 30 years: 119 basis points, down from 187

From five years to 10 years: 33 basis points, down from 52

From five years to 30 years: 80 basis points, down from 114

¹  Bloomberg Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital). The S&P 500 Index is a broad-based, unmanaged measurement of changes in stock market conditions based on the average of 500 widely held common stocks. S&P 500 index data sourced from Bloomberg, using a total return including dividend reinvestment. Data as of 10/31/17.

² “OPEC Monthly Oil Market Report,” http://www.opec.org/opec_web/static_files_project/media/downloads/publications/OPEC%20MOMR%20August%202017.pdf, November, 13, 2017, p. 30.

Despite the outflows and a generally weaker high yield market, new-issues continue to print as the demand for yield will not subside despite some short term volatility.  There were two deals that printed yesterday that traded higher in the secondary.  There are still a dozen deals on the forward calendar.  Given outflows and a temporary risk off mentality these issuers might have to pay a fraction higher to attract fresh money.  Several retailers are reporting today, including Kohl’s, Macy’s and Nordstrom which may add volatility to this sector.

Despite oil jumping to a 28 month high, the 10-year Treasury yield falling to 2.31% and equity markets hitting new highs, the high yield market has flat lined—which we would view as healthy.  Also, Moody’s Liquidity Stress Index dropped to a record low of 2.7% in October, which we believe also signals a healthy high yield corporate environment.  Two new-issues priced yesterday with a half dozen on the calendar.  This should pick up as earnings blackout periods end.

I spoke at the ETF.com “Inside Fixed Income” conference, and the elephant in the room was where rates are going. As we have said for a few years now we feel the 10-year will stay closer to 2% than 3% based on many different factors we see.  You can read our recent commentary explaining this, “Lower for Longer.”  It is becoming harder to ignore the yield curve flattening, the 2s/10s curve is flattest it’s been in about a decade, so do your own work, don’t buy the media pundits.

Only one new-issue priced yesterday, while six are on the forward calendar.  We expect that it will remain a bit slow until some earnings blackout periods end and we move beyond some of this week’s important announcements referenced above.

Regardless of what happens, many investors need some tangible yield into their portfolios, and we believe high yield corporate bonds can provide this yield. The Moody’s Liquidity Stress Index dropped to 2.8% mid-October, revisiting record lows of April 2013, which indicates to us the fundamentals in this market are healthy, but many prices and yields are not so healthy. With one of the big index-based high yield ETF’s printing a 4.96% 30-Day SEC yield for October¹, we believe there is better yield to be had in an actively managed high yield strategy.  For more, visit www.advisorshares.com/fund/hyld.

¹  The 30-day SEC yield is an annualized yield that is calculated by dividing the investment income earned less expenses over the most recent 30-day period by the current maximum offering price.  Data as of 10/31/17.  Yields and other statistics are no guarantee of actual performance.

While rates have moved up over the past few months, the percentage of the JP Morgan Loan Index trading above par stands at 74.7%¹, exceeding the high reached in early August.  We believe it is not time to be reaching aggressively for yield, but we also don’t see many of the low yielding indexes and index-based products as reflective of some of the yield the high yield market has to offer; rather we believe that focus should be on a more concentrated portfolio with attractive credits that can provide above average tangible yield and YTW.

1  Jantzen, Nelson, CFA and Peter Acciavatti, “JPM High-Yield and Leverage Loan Morning Intelligence,” J.P. Morgan North American Credit Research, 10/30/17, https://markets.jpmorgan.com.

If you look at the Moody’s Liquidity Stress Index, it dropped to 2.8% in mid-October reaching lows not seen since April of 2013. This points to corporate liquidity strengthening and we see no imminent fear of accelerating defaults.  Another indicator on the health of the high yield market is companies rated B3 or lower have declined, indicating that the overall health of the junk bond market is improving and it is composed of better quality credits. Only three new-issues priced for a paltry $460M, with much of the slowness driven by it being earning season as many companies have a blackout period in effect.  There are six deals on the forward calendar.