US Credit Update – Focus on High Yield Energy

Highlights from U.S. credit markets:

  • Investment grade finds some footing
  • High yield maintaining composure
  • Fair value update
  • High yield energy outperforming again
  • Downside risks for crude oil
  • Corporate desk comments

Investment grade finds some footing

The pendulum swung back in the direction of safe assets during the quiet holiday week. The Bloomberg Barclays U.S. investment-grade total return index was the top performer among the broad indices at 0.6%, led by U.S. industrial subindex. High yield stumbled, inching higher by only 0.1%. Range-bound conditions remain firmly in place, however, and the 3-month total return picture remains much the same with risky assets outperforming.

High yield maintaining composure

Investment grade still lags well behind both Treasuries and U.S. high yield.

Fair value update

Improvements in investment grade performance are supported by our fair value models. Fair value and actual rose in tandem last week for investment grade, and for the most part are well within range. High yield continues to look slightly overvalued but continued to converge with our fair value estimate.

 High yield energy outperforming again

Although the broad U.S. high yield index remains stuck in the mud, high oil prices continue to drive outperformance in high yield energy. The margin of outperformance has risen to nearly 1.5%.

Digging a little deeper into industry groups within the energy sector, high yield outperformance remains concentrated in those industries with the closest ties to spot oil prices. Oilfield services have the seen high yield outperform by the largest margin with a 6.9% difference between the average year to date return. The exploration & production industry is next with high yield besting their investment grade peers by 3%. Riskier borrowers in the refining and marketing industry have trailed investment grade.

The chart shows year to date returns for high yield (X) and investment grade (O), along with the average (vertical line). 

Downside risks for crude oil

We do continue to see evidence of downside risks for crude oil. Our fair value estimate for crude oil is still well below actual by nearly 20%.

While this can be attributed to supply concerns related to Iran and Venezuela, other financial markets have not responded as expected to the latest run higher in oil prices. We discussed this in Newsclips in late June. Our fair value estimates are based on the financial market performance of other asset classes. All other asset classes have moved in favor of lower oil prices over the past several weeks as crude rallied.

Corporate desk comments

Our corporate desk had the following comments on Friday:

Flows were moderate given the holiday week, stocks indices edged higher (S&P +1.5%) and
spreads throughout sectors tightened roughly 0.5 to 2bps. 

We saw active buying in investment grade bonds targeting 2021 to 2022. A variety of names (Deere, Fedex, Colgate, JPM, Metlife, Kraft, Verizon) yielding 3% to 3.7%. We also saw interest in Biotechnology—Biogen was in the news, its stock was up more than 20% as their Alzheimer’s trial results was a “rare bright spot.”

There was a Bloomberg story late in the week mentioning investors from Japan “have plowed record amounts into U.S. stocks, corporate bonds, and agency-backed securities. The Barclays U.S. Agg Corporate Avg OAS index has widened near 40bps since early February, the back up in spreads is enticing buying.

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