CIO's Perspective: 2019 Half-Time Leveraged Credit Review and Outlook

Posted on July 26, 2019

1st Half 2019 Review

After experiencing the worst quarterly performance in over three years in the fourth quarter of 2018, the high yield market bounced back in 2019, particularly in the first quarter, generating the strongest first half performance since 2009. A major driver of this rebound in performance occurred at the beginning of the year when the U.S. Federal Reserve (“the Fed”) signaled a more accommodative monetary policy stance going forward. 

The shift in monetary policy was solidified in March when the Fed, after increasing rates four times in 2018, cut its forecast for rate hikes in 2019 from two to zero. Interest rates declined across the board, broadly benefiting fixed income assets. This produced a positive swing in investor sentiment, which combined with a continued relatively strong U.S. economy, led to high yield bonds returning 10.16% during the period.

Technicals also supported the high yield market in the first half of the year. Specifically, new issuance volume has been relatively anemic while inflows into high yield mutual funds were meaningfully positive after experiencing net outflows in both 2017 and 2018. The increase in buyers created favorable high yield bond supply/demand dynamics, supporting price appreciation in the secondary market.

Within the broader high yield market, BB-rated high yield bonds were the top performing quality bucket during the first half of 2019, while CCC-rated bonds underperformed though still managed to generate impressive returns on an absolute basis (Exhibit 1). The BB-rated segment typically has a longer duration than the B-rated and CCC-rated segments, and thus BB-rated bond performance benefited disproportionately from the decline in interest rates that occurred during the period. Performance by sector reveals that Retail (13.2%), Banking (12.4%), and Financial Services (11.7%) were the top performers in the first half of 2019. Conversely, Energy (7.5%), Transportation (7.6%), and Real Estate (8.0%) were the biggest laggards.

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