Corporate Fundamentals Appear Solid
Given what we have seen in the US with the rebounding economy and a strong first-quarter earnings season, we believe corporate fundamentals look positive. In our view, there is pent-up demand for products, and we are seeing this translate into shortages in areas such as building materials and autos.
We expect high yield corporates to see revenue growth or recovery, depending on how they were initially hit by the pandemic. We also expect leverage ratios to improve and interest coverage ratios to stay high. Corporates do not appear to be taking on much more debt. Therefore, overall we believe high-yield companies appear in good shape.
Opportunities in Reopening Sectors
We believe the strong growth in the US economy and vaccination news has increased investment opportunities in sectors such as energy and leisure. Leisure is multiple sectors including airlines, gaming, hotels and entertainment and as a group comprises a significant portion of the US high yield market. We are seeing a number of opportunities in these areas as the US economy reopens.
B Rated Bonds Are in the Sweet Spot
In the three components of high yield (BB, B and CCC rated bonds), we are seeing an improvement in defaults and investments in all areas. However, in the CCC rating segment, following a period of strong performance, spreads are now tight compared to historic levels. Meanwhile, with the likelihood of an increase in rates, we believe BB-rated bonds could be susceptible to duration risk. Therefore, bonds in the B rating category are the current sweet spot in our opinion; default risk is low, and the upgrade/downgrade ratio is positive. The spread component will also help absorb any rate increase.
Rates (or Volatility) Could Move Higher
In our view, rates, which have already moved a long way, are likely to increase over this year, although in a more manageable way than the aggressive moves seen from mid-January to mid-March. We do not see duration for the time being as a major concern. However, if the US economy continues to run hot, the Federal Reserve (Fed) could change its forward guidance and start to taper its quantitative easing program. It will be important to see how the Fed communicates this to avoid a repeat of the 2018 taper tantrum which led to a spike in volatility and spread widening.