An unexpected rise in junk bond yields has led to a sharp fall in prices, and experts think the worst is yet to come. Note that the junk bond market is operating from a more pessimistic outlook than the equity market. This divergence is not uncommon.
High-yield, high-risk bonds are off to their worst start ever, and the biggest investors say there’s no recovery in sight.
Junk bonds have fallen an average 3.9 percent this year, losing about $35 billion, according to data from Merrill Lynch & Co. indexes. Some funds managed by John Hancock Advisers LLC, OppenheimerFunds Inc. and Fidelity Investments are down more than 7 percent, showing that even the largest investors were caught off guard by the collapse.
While the Federal Reserve has slashed benchmark interest rates by 3 percentage points since September, it has been unable to get investors to increase their purchases of the riskiest assets. The declines are choking off financing for speculative- grade companies, boosting defaults. The debt is likely to “struggle” for months as the economy enters a recession, according to JPMorgan Securities Inc., the top high-yield research firm in Institutional Investor magazine’s annual poll.
“The moves have been absolutely vicious,” said Arthur Calavritinos, whose $1.2 billion John Hancock High Yield Fund has lost about 9.8 percent since December. The Boston-based manager said it’s the worst market since he started in finance in 1985.
Just 11 companies have issued $9 billion of junk bonds in the U.S. in 2008, according to data compiled by Bloomberg. This time last year, 83 had sold $39.5 billion. Junk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s.
The slump is hurting more companies than ever before. Some 51 percent of U.S. corporate borrowers are rated below investment grade, up from 28 percent in 1992, according to S&P.
About $1 trillion of the debt is outstanding, compared with less than $10 billion 30 years ago. Two of the world’s biggest automakers, Detroit-based General Motors Corp. and Dearborn, Michigan’s Ford Motor Co., were cut to junk within the past three years, as was San Antonio-based Clear Channel Communications Inc., the largest U.S. radio broadcaster.
Investors are demanding yields averaging 8.07 percentage points more than Treasuries, up from 5.92 percentage points at the end of last year, and a record low of 2.41 percentage points in June, index data from New York-based Merrill show. The spread reached 8.62 percentage points on March 17, the most since 2003.
“`Ouch’ would be an understatement,” said Stephen Antczak, a high-yield strategist at UBS AG in Stamford, Connecticut. In December he predicted the debt would rally in January. Now he says he’s “still bearish” and expects spreads to widen 0.5 percentage point to 1 percentage point next quarter.
Peter Acciavatti, head of global high-yield strategy at JPMorgan in New York, predicts spreads will remain more than 8 percentage points “for some time, or at least until some remnant of an economic recovery is in sight,” he said in a research note March 14. The biggest difference recorded by Merrill, whose index started in 1996, was 11.2 percentage points in October 2002….
“We’ve had no frame of reference for this kind of pervasive credit crisis,” said Marilyn Cohen, president of Envision Capital Management in Los Angeles. “The problems are so huge, and they’re everywhere.”….
The amount of distressed debt in a Merrill index tripled to $175 billion this year, and was only $4.4 billion in March 2007. Bonds that trade at a spread of 10 percentage points or more over Treasuries are considered distressed because investors are concerned that the borrower will default. More than 180 companies have debt that is now considered distressed, Bloomberg data show….
The market isn’t “necessarily pricing in the recession that’s most likely coming,” said Henry Choi, managing director and head of the U.S. high-yield team at Morgan Stanley Investment Management in West Conshohocken, Pennsylvania.