To junk or not junk - the last role of the dice
It seems we not only have missed the bonanza of 2012 so far, but we also see a redefining of risk in the markets. And we are talking here about sub-investment grade corporate bonds, AKA high yield or more commonly : Junk. And if we are to believe various comments, the B and C rated companies of today are "the sweet spot" and "new safe havens".
Looking at the performance table underneath (ML Merril Lynch indices), corporate bonds in Europe and especially those of less quality (single B) had a fairly good run into 2012 and that might be an understatement :
Note : also the fairly good performance of sovereign bonds so far is eye-catching but that has more to do with LTRO and the performance of Italy, Ireland and Belgium in the index, respectively 13%, 9,5% and 6%, with core-european bonds registering in between 1 and -1,4%.
So why traders/investors claim it's safe haven ? Well some statistics point to this. If risk is measured by volatility, BB/B bonds have lately outperformed US treasuries with a volatility of 5,2 - by the way the lowest of all bond indices !! - versus 5,6 for the overall Treasury index. Broadening the timeframe and asset class, the old safe haven treasuries even perform very bad : the rolling 60 day historical volatility on 10y UST registered 36 in March, the highest on record, while the one on the S&P 500 reached 19 last month. But let's give the floor to the following high yield portfolio managers with different motives and analysis:
"BB has really been the sweet spot. They are right in between the more rate sensitive investment grade part of the market - where volatility is linked to treasury rate movements - and the more credit sensitive part of high yield (B-CC)"
"I understand the performance of BB but I am underweight, I am not being rewarded for credit and interest rate risk. The current optimism has more to do with hope in the recovery and the fact that markets are pricing in a series of interest rises before the official target date set by the FED (2014). I wouldn't be surprised if portfolio managers will start to shift towards the C segment"
So basically, the market is fully positioned for a sustained global business cycle recovery where most likely the C companies of today will be acting as "safe haven performing" assets tomorrow. Well, I always raise my eyebrows when C rated assets - one step from D or Default - are the supposedly new benchmark for investors. It has probably more to do with monetary policy over the past few years blowing bubbles. Luckily, we found comments nicely summarizing the dilemma and traps which investors currently face :
"Technicals and unlimited provision of liquidity favor credit and are overriding fundamentals right now. This can continue for a while but certain risks are certainly present ; geo-politically, sovereign debt reflaring, global growth etc. If benchmark government rates start to move up for one reason or another, credit spreads could receive a blow as well. Let's hope policy makers use the window at hand wisely because it's the last role of the dice"