After Surge, High Yield Still Has Room to Run

David Sekera: Over the past few weeks, the high-yield market has come roaring back. In fact, for the week ended March 2, more than $5.7 billion of inflows surged into high-yield ETFs and open-end mutual funds. According to our data going back to June 2009, this represents the single-greatest weekly inflow into the high-yield asset class. The second-greatest weekly inflow was $4.3 billion, which occurred in October 2011. That was shortly after the Fed launched Operation Twist, and the equity markets were on their way higher.

Earlier this month in our Credit Weekly publication, we stated that considering credit spreads were near levels more consistent with recessionary periods, the emerging snap-back rally in high yield had further to go if the economy continued to improve and oil prices remained stable or moved higher. Little did we realize how much that statement underestimated the situation.

Since hitting their lows, oil prices have surged 45%, and based on recently released economic metrics, the U.S. economy appears to remain on a steady, albeit low-growth, expansion.

This led to the extraordinary rally in the high-yield market in which the average credit spread of the Bank of America High Yield Index has tightened 170 basis points since its wides in mid-February and is now almost unchanged on the year. Currently, the index stands at a spread of 715 basis points, which is approximately 130 basis points wider than its long-term average.

So, excluding any exogenous shocks to the U.S. economy, the high-yield asset class likely has further room to run. While we continue to expect default rates to rise in the energy sector over the course of the year, higher oil prices will result in greater recovery values, and continued economic expansion will limit default rates among the other sectors.