NEW YORK, Jan 11 (IFR) - The US high-yield market saw huge demand this week as investors look to put large amounts of cash to work, with heavy inflows reinforcing the strong technical backdrop.
Lipper reported US$1.113bn in inflows to high-yield mutual funds and ETFs for the week ending Wednesday, with hundreds of millions of dollars pouring into the market on a given day.
The positive shift in the market following the fiscal cliff agreement at the start of the year, combined with the extended quiet period over the holidays, has allowed the technical backdrop to continue to improve.
That build-up of cash is combining with a relatively light new issue calendar, as M&A flow builds slowly and many opportunistic issuers have already come to market for their upcoming refinancing needs.
“The market remains very constructive,” said a banker. “The calendar has been quieter than we have expected. There are a number of deals getting added as people ramp up post holiday, but most of the deals have been on the smaller side.”
Indeed, demand is far outpacing supply as the new issue calendar builds slowly in the new year. This week, nearly US$8bn in US dollar deals have priced from 13 issuers.
Given such huge appetite, it was no surprise that all of the deals this week have so far done exceedingly well, with upsizes across the board and pricings on the tight or even through the tight end of talk.
Demand for Bombardier’s deal was such that the company dramatically doubled its offering to US$2bn.
In the same vein, secondary performance has been very good as well, with many of the deals trading up at least two points.
But as the high-yield picture remains rosy, investors still expect volatility this year, especially as it relates to the political and economic climate. While the fiscal cliff agreement eased major concerns at the start of the year, investors say there are plenty of holes.
“We’re going to see another tug of war. Earnings will remain weak and global growth will remain weak,” said Timothy Gramatovich, chief investment officer at Peritus Asset Management.
“That story will continue, but countering that I think we are seeing this risk-on mentality. Investors have cash and earn nothing on it. So the first quarter will be a trading game. After that we will see if some economic trends can be established.”
Gramatovich said in the current climate, bonds are more interest rate-sensitive given the lower coupons including on high-yield, but he expects default rates to remain below their historical averages for the next couple of years.
“The use of proceeds and leverage metrics don’t support a rising default environment even with economic weakness. Couple this with the massive refinancing wave just completed and you don’t have the maturities coming due.”
This means there is plenty of room for spread compression.
“All-time spread lows for high yield over Treasuries have breached 300 basis points twice,” said Gramatovich. “So even a rise to 1% for the five-year Treasury would suggest that high yield could trade down to a 4% handle. This is why rates are so important.”
Yesterday, the option adjusted spread on the Barclays high-yield index dipped below 500bp for the first time since June 2, 2011, falling to 497.3bp compared to 519.4bp at the start of the year.
Meanwhile, the yield-to-worst tightened further to 5.75% on Thursday, having dropped below 6% (to 5.96%) at the start of the year.
Marty Fridson, CEO of Fridson Vision, a financial research firm based in New York, said there is good reason to believe that high-yield bonds continue to be rich by a fair margin given the current rates.
In noting Moody’s Covenant Quality Index, which shows that covenant quality has been deteriorating steadily since mid-2012, he said: “The covenant trend suggests that investors are desperate for yield and are willing to accept comparatively unfavorable terms to get it. That sort of desperation is ordinarily associated with overly rich pricing as well.”
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