High-Yield Bonds React to Sub $50 Oil

by:
Chief Portfolio Strategist, MainStay Investments

Energy is one of the largest sectors in the high-yield bond market, so it didn’t go unnoticed when oil prices recently reached three-month lows amid supply concerns. A week ago, the U.S. Energy Information Administration (EIA) reported an 8.2 million barrel crude oil inventory build. That was followed this week by a 237,000 barrel reduction in stockpiles.

The EIA forecasts Brent crude oil prices to average $55/b in 2017 and $57/b in 2018, above current levels.

Yields above 6% Again

With high-yield bonds, as represented by the BofA Merrill Lynch U.S. High Yield Master II Index, yielding more than 6% again — much higher than investment-grade bonds or developed country sovereign debt outside the U.S. — the income generated by the asset class remains attractive. What’s more, spreads are back to levels seen earlier this year and above the tightest levels of past spread-tightening regimes of the 1990s and 2000s, when periods of compressed spreads lasted as long as the fundamentals held up (see chart below).

High-Yield Spreads

Source: Thomson Reuters Datastream. Data as of 3/15/17, last data point 3/14/17. The Spread is calculated by Datastream using the BofA Merrill Lynch High Yield Bond Master II Index and the yield on Treasurys.

The Benefits of Long-Time Horizons

Short-term price gyrations can create opportunities in the high–yield bond market for long-term investors. In the past 20 calendar years, high-yield bonds have produced positive returns 17 times (85%), with rolling 10-year periods generating positive returns in 100% of the completed instances, and average annualized returns exceeding 7% (see chart below). Past performance is not a guarantee of future results.

High-Yield Bonds Produced Positive Returns More Frequently over Longer Holding Periods

Month* 1-Year 3-Year 5-Year 10-Year
Average Annualized Return 7.31% 7.50% 7.98% 9.14% 9.35%
Average Annualized Standard Deviation 9.15% 12.70% 11.92% 12.20% 9.21%
Sample Size 242 231 207 183 134
Times Negative Return 74 53 21 8 0
Percent Negative Return 30.58% 22.94% 10.14% 4.37% 0.00%
Times Positive Return 168 178 186 175 134
Percent Positive Return 69.42% 77.06% 89.86% 95.63% 100.00%

Sources: Bloomberg, MainStay Investments. Data as of 3/15/17, last data point, 3/1/17. Risk return metrics and historical performance are calculated by MainStay Investments, using the Bloomberg Barclays High Yield Index. The calculations use 20 years of monthly returns (1997). Return and standard deviation calculations are annualized averages using monthly, rolling one-year, rolling three-year, rolling five-year, and rolling 10-year returns. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index. Standard deviation is a measure of the dispersion of a set of data from its mean. If the data points are further from the mean, there is higher deviation within the data set. Standard deviation is calculated as the square root of variance by determining the variation between each data point relative to the mean.

Odds ‘n’ Ends

The long-term strategic case for high-yield bonds remains intact, as adding high-yield exposures to a portfolio of core bonds has historically improved the return-risk profile across different locations along the risk spectrum. High yield has also historically outperformed investment-grade bonds during past periods of rising interest rates, as have short duration, high-yield, and floating rate loans.

Conclusion

High-yield bonds, as represented by the BofA Merrill Lynch U.S. High Yield Master II Index, are yielding above 6% again, following price gyrations owed to a drop in oil prices. Spreads are back to early 2017 levels.

There is no assurance that the investment objectives can be met. It is not possible to invest directly in an index. All investments are subject to market risk, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market.

Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high-yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets’ country of risk, based on Barclays EM country definition, are excluded.

BofA Merrill Lynch U.S. High Yield Master II Index – The index measures the performance of high yield bonds.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. The MainStay Funds® are managed by New York Life Investment Management LLC and distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302, a wholly owned subsidiary of New York Life Insurance Company. NYLIFE Distributors LLC is a Member FINRA/SIPC.

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Charlie Reinhard

Chief Portfolio Strategist, MainStay Investments

As head of portfolio strategy at New York Life’s MainStay Investments, Charlie Reinhard leads investment thought leadership and portfolio construction efforts across MainStay mutual funds and IndexIQ ETFs

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