CIO’s Perspective: 2018 High Yield Market Review & 2019 Outlook

Posted on January 18, 2019


Following two years of steadily declining spreads and strong returns, high yield bond performance turned negative in 2018. U.S. tax reform, healthy economic growth and tightening monetary policy helped to push Treasury yields higher for most of the year. The rise in yields led to weak performance for all fixed income products, including high yield bonds, which produced a loss of -2.27% following a volatile fourth quarter.

During the first half of the year, the increase in interest rates led investors to redeem from high yield bond mutual funds, which exacerbated price pressure especially amongst higher quality, longer duration bonds. Returns rebounded during the summer months, as outflows slowed and primary market activity for high yield bonds declined, resulting in secondary market price increases. At the end of the summer, CCC-rated bond performance was well ahead of its higher-quality peers. However, in the fourth quarter, the high yield market experienced a spike in volatility brought on by several factors, including heightening trade tensions between the U.S. and China and its potential impact on the global economy. This renewed volatility led to a significant sell-off in high yield bonds and erased all of the gains produced during the first three quarters of 2018 (Exhibit 1).

Performance by sector reveals that Healthcare (1.6%), Telecommunications (1.1%) and Utility (1.0%) were the top performers in 2018. Conversely, Automotive (-8.3%), Energy (-6.4%) and Banking (-4.7%) were the biggest laggards. The spike in volatility in the fourth quarter, especially in December, was particularly hard on Energy sector bonds, which were the third best performers year to-date as of September 30, 2018. However, a 39% decline in the price of oil during the fourth quarter completely reversed the sector’s fortunes. In addition, the poor performance of Energy sector bonds was a significant reason for the weakness among CCC rated bonds in the fourth quarter.

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