Much has changed in the past three months: Clarity around election outcomes emerged, successful vaccines were announced and have been distributed at an increasing rate, unprecedented fiscal stimulus once again was passed, and additional steps towards reopening the economy continue to unfold. This combination of factors drove more than a doubling of five-year U.S. Treasury bond yields in just three months.
At the same time, several important factors impacting markets have not changed: Capital markets remain wide open across nearly all sectors, default rates are still expected to be very low, and high yield spreads have remained mostly unchanged on a year-to-date basis. The persistent income advantage of the high yield asset class within fixed income has also remained in place.
This brings us to our key theme for high yield today: “more certainty, higher yield.”
With high yield spreads unchanged in 2021, we have a situation where more certainty regarding robust economic growth has been coupled with a moderately increased yield. We acknowledge that absolute yields of 4.5% for high yield are not what markets are accustomed to. However, with over 60% of global fixed income markets yielding less than 1%, the relative attractiveness remains. The U.S. is on a clear path to robust economic growth, and we expect widespread credit improvement that could lead to many more rising stars and opportunities for capital appreciation. We think the combination of relative yield and a constructive outlook makes the “higher” yield available in high yield today an attractive opportunity for investors.
To position portfolios to capitalize on this environment, we are focusing on several key themes in portfolios:
- Seeking to maintain an income advantage by out-yielding the market.
- Assessing activity levels in the economy as it reopens to stay ahead of secular shifts that could emerge as permanent disruptions to issuers.
- At the margin, we are less concerned about duration risk in portfolios today relative to the start of the year. We are seeing pockets of opportunity open up in higher quality credit.
From here, we think the traditional negative correlation between rates and high yield spreads could reemerge as improving economic activity drives credit improvement and defaults remain lower than historical averages.
Clarity around key market drivers has greatly improved, and we believe this backdrop should provide more confidence in seeking the income opportunity available to investors in high yield.