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Backing Out the Energy Effect on High-Yield Bonds

High-yield bonds have been thrown into turmoil because of falling oil prices, but excluding the energy sector, high-yield spreads have only risen slightly.

Backing Out the Energy Effect on High-Yield Bonds

Tim Strauts: Today we are going to look credit spreads for the high-yield bond sector. A credit spread is defined as the difference in yield between two bonds of similar maturity but different credit quality. For today's chart, we will be showing the credit spread for high-yield bonds over U.S. Treasuries. The green line is the credit spread since 2013 for the high-yield bond sector, which is all bonds with a credit rating of less than BBB-. The blue line shows the credit spread of only high-yield bonds issued by energy companies. Finally, the orange line shows the credit spread of the entire high-yield category minus the energy sector.

As you can see from the chart, the credit spreads of the energy sector have risen dramatically as oil prices have declined. The average high-yield energy bond is yielding an incredible 12.6% above comparable government bonds. While this yield is fantastic, the market perceives that many of these companies are likely to default in the next few years. The turmoil in the high-yield market caused a very large $11.2 billion outflow from mutual funds and ETFs that invest in high yield in December. Now, if we exclude the energy sector, the rest of the high-yield market looks much better as credit spreads have only risen slightly.

In conclusion, high-yield bonds have been thrown into turmoil because of falling oil prices. If an investor is looking to invest in high yield today, I would suggest avoiding the lowest-grade CCC bonds, which are most likely to default.

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