Durable Goods orders were below expectations but still point to strong corporate spending while Capital Goods orders beat expectations.  The more important Inventory number was flat, so nothing to gauge either way.  Our domestic economy seems to be in solid shape, but what about elsewhere?  If the world economy is doing so well why is the ECB still in the stimulus phase, still buying assets and hinting that the interest rate program won’t change until next summer?

No high yield bond new-issues came yesterday and that leaves four deals on the forward calendar for a total of ~$1.8B.  Earnings are kicking in, which means quiet periods are being implemented so the continued slow new-issuance pace will likely continue.

* Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).

The high yield bond market continues to have a bid in the secondary market as cash is flowing there with the absence of new-issues fueling that.  Some of the lack of new-issues is because many companies are issuing floating rate loans instead of bonds.  We will have more to say on this in our upcoming mid-year writing.

* Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).

In what could be viewed as a continued sign of a strong corporate health, if you put any credence in the ratings agencies, the number of companies rated B3 or lower are at a three year low.  Our take is bonds and loans are either AAA or D (in other words, they either pay or don’t), and you have to do your own work to determine the credit quality.  We don’t believe that buying an index is the best course of action in this environment.

Oil is up today after several weeks of weakness and it has entered contango as the threats between the US and Iran rage on and the fact that Israel shot down a Syrian jet.  Uncertainty in the Middle East is always a catalyst for higher oil.

An interesting thing to ponder is all of the talk about the lack of liquidity in the S&P 500.  There have been so many products launched of various styles and strategies, the float has been eaten up.  Also, throw into the mix all of the companies doing stock buy-backs, and this is where you are.

* Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).

Earnings season kicks off in full force over the next week, with many high yield issuers among those announcing, so we expect we will see a continued lack of new issuance supply.  There was $3B issued last week and only ~$5.5B for the month which is the lightest July since 2008.

Oil is creeping toward $70/barrel again on President Trump and Iran’s strong talk and the rig count in the US fell by five last week.

* Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).

Outflows from index tracking funds and the asset class overall are putting pressure on the secondary market and there are only a few new-issues on the forward calendar with two pricing yesterday for ~$1.2B.  Loans funds continue to see inflows and Lipper is anticipating the largest inflow in six weeks, but we believe investors need to beware.

There have been a ton of investors throwing cash at the floating rate loan market this year.  We think one of the biggest problems this cycle will be the collateralized loan obligations (CLOs).  While we see many attractive opportunities in the off the run loan market (which we view as a less efficient market, with more “orphaned” credits that aren’t widely followed), loans overall have been very popular and are sporting far more leverage than in past cycles.  The value of having a first lien in a 5-6x levered company may not be worth that much if it is the only debt outstanding, and for those credits that are impaired, the recovery rates may be well below historical averages.  So this potentially may be a far bigger mess down the road, and may create even more opportunity once it begins to unravel.  We see a good amount of “research” discussing moving senior into loans but that is a misnomer in many cases.  Tourists in that asset class need to be aware.  Loans are simply another great opportunity set; there are lots of good ones and lots of bad ones.

There is always value in the market but we believe that where we are in the cycle, investors should be bond/loan pickers.  According to JP Morgan, there are $381bn of high yield bonds callable over the next year, but only $57bn of that is now trading above its call price.²  That means there is ~$330B trading below call prices and it is the job of the high yield manager to find these securities and determine which of those are attractive holdings, thus allowing for coupon income as well as potential capital appreciation.  There are many different reasons these are not trading at the call levels and the expertise is to find the ones where it a situational reason rather than a bigger fundamental reason.

¹ Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).

² Jantzen, Nelson, CFA and Peter Acciavatti, “JPM High-Yield and Leverage Loan Morning Intelligence,” J.P. Morgan North American Credit Research, 7/13/18, https://markets.jpmorgan.com.

Oil is down again today approaching the 100 day moving average.  Normally when we see oil down during the peak driving season and gasoline prices higher, we see refiners buying cheaper oil to make and sell more expensive gas.  This is not happening as gas has weakened more than oil. Also, it looks like the Saudis, Libyans and Iranians are producing slightly more expected, thus causing weakness.

There was a slight outflow yesterday for high yield mutual and exchange traded funds and no new-issues priced, but two issuers are on the docket for today for ~$2B in proceeds.  This scenario and the fact the US economic climate looks much better than that for many non-US corporate debt issuers, the bid remains in the domestic secondary high yield bond market.

* Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).

Lipper reported inflows of +$1.85 billion into high yield bond mutual and exchange traded funds, while floating rate bank loan mutual and exchange traded funds had a +$212 million inflow for the week ending 7-11-18. Fund flows into bonds were flat on Friday, while loans continue to see inflows.  The technicals for high yield have been a very interesting and confusing mixed bag.  Outflows from high yield mutual funds and ETFs have been huge both in 2017 and so far in 2018, so that creates a significant headwind.  But real money investors have been playing a bigger role and they remain strong.  People often forget about how much coupon cash flow and proceeds from calls, maturities, and tenders comes in weekly that needs to be re-invested.  The supply side has been considerably below last year, which has been a significant positive offsetting the fund out flows.  So overall, high yield market technicals are neutral.  We would expect new issue supply in bondland for 2018 to be well below what we saw last year.

There have been a ton of investors throwing cash at the floating rate loan market this year.  We think one of the biggest problems this cycle will be the collateralized loan obligations (CLOs).  While we see many attractive opportunities in the off the run loan market (which we view as a less efficient market, with more “orphaned” credits that aren’t widely followed), loans overall have been very popular and are sporting far more leverage than in past cycles.  The value of having a first lien in a 5-6x levered company may not be worth that much if it is the only debt outstanding, and for those credits that are impaired, the recovery rates may be well below historical averages.  So this potentially may be a far bigger mess down the road, and may create even more opportunity once it begins to unravel.  We see much “research” discussing moving senior into loans but that is a misnomer in many cases.  Tourists in that asset class need to be aware.  Loans are simply another great opportunity set; there are lots of good ones and lots of bad ones.

There is the constant question of active versus passive management.  This is the time in the cycle where asset class runs have been spent.  We have often said that as an active manager, we don’t see our position in as managing money, but rather managing risk.  We believe this is absolutely critical going forward.  We believe that investors should avoid many of the deeply subordinated and highly levered transactions, thus actively managing risk is crucial.  The large high yield index-tracking ETFs have seen heavy inflows over the past couple weeks, but investors should look into the yields and returns many of these funds have generated so far this year—they might not like what they see.  We believe that active management is better positioned for the current environment on both the yield generation and risk side.

* Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).

There is little movement in the 10-year Treasury following a stronger than expected PPI number this morning.  Costs for truck transportation of freight was the highest since 2009; fuel and wages are driving this as there is a big demand for drivers.  Interesting enough for the consumer is food prices fell 1.1%—will this be seen in tomorrow’s CPI report?

Moody’s reported that the US speculative grade default rate fell to 3.4% in June from 4.0% in March.  Moody’s analysts expect the Media: Advertising, Printing & Publishing sector to see the highest number of defaults in the US.  They also stated that despite the tariff banter, overall global growth and liquidity are sufficient to keep corporate credit quality steady.

Four high yield bond new-issues came to the market yesterday, all drive by deals that priced at the tight end which indicates that the market is hungry for new paper.  This makes sense as we have seen three straight days of inflows.

* Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).

In the latest quarter, distressed debt funds took in a good amount of cash in the private fund space.  Given that many of the larger index-tracking products are giving investors what some see as a mediocre dividend, it looks like investors are searching for higher returns in distressed debt.  What will be the catalyst?  You know our opinions on the ratings agencies as per their effectiveness in assigning credit ratings—we believe they often get it wrong—but their data on corporate health and defaults is useful and  is not showing distressed debt will be plentiful in the near future, and for what is out there, investors need to be selective as to what specific credits they invest in.

The 10-year US Treasury yield sits here at 2.87%, down from the multiyear high of 3.11% on May 11^th after many said we were going to 4%.  Many factors go into where rates are going and if you just follow the propaganda machines out there you will often be wrong—often deep pockets get on TV to sell their products.  We believe that active research is required and if you go back and read our writing from the beginning of 2017 www.peritusasset.com you will see why we did not see a big move up in rates and still don’t.

There are only three high yield bond new-issues on the forward calendar for this week and thus the inflows into the asset class are pushing the large, on-the-run names higher and pushing several of the index tracking ETFs to premiums over NAV.

* Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).

The June employment report came in strong and wage inflation does not appear to running above expectations.  With the rising labor force participation helping lift the unemployment rate 0.2% to 4.0% this too should give the Fed confidence the economy is still growing on target without the wage inflation they fear will require them to act quicker.  Keep an eye out for the PPI and CPI number for June due out this week.

* Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital).