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Sentiment in the media and in many corners of the marketplace that holds that high-yield corporate debt is in “bubble” territory may be missing some key factors currently shaping the bond landscape, according to
Fran Rodilosso, fixed income portfolio manager at Market Vectors ETFs.
“I think there is a difference so far between what we are seeing at the beginning of 2013 and the type of credit bubbles we have seen historically,” said Rodilosso. “A bubble is built on excessive leverage, and modern bubbles have been fueled by leveraged buyouts, real estate speculation, and structured products with a high degree of embedded leverage.”
“No doubt some of these phenomena are creeping back into the market, and leverage at the company level, to generalize, did start rising during the latter part of 2012,” he added. “But whereas during a more ‘classic’ bubble a vast majority of debt issuance has historically funded takeovers, dividends, and massive capital spending, 2012’s record issuance was still, for the most part, done for the purpose of refinancing. That refinancing was done at lower interest rates, reducing the cost of debt for many borrowers, while also reducing the amount to be paid back over the next two years.”
He continued, “Yields have been pushed down by a highly aggressive central bank policy, with the result that yield-oriented investors have been pushed into owning lower-rated credits. As a result, the yields on riskier debt are as low as they have ever been. But the credit spreads, the difference between the yield on a high yield bond and a Treasury security, are actually closer to their historic average.”
According to Rodilosso, that fact implies that there still remains some cushion in high yield bonds against a moderate rise in interest rates, a cushion he notes we are already seeing in action thus far in 2013. “I think the point is that bonds are not ‘cheap’ in the sense that there is considerably less upside than there was a year ago, and credit markets are vulnerable to a significantly higher move in US interest rates. But, putting aside the actions of the federal government, the private sector does not yet appear to me to be at the excessive level of leverage that would lead to imminent liquidity issues and a spike in default rates, at least not yet.”