A rally in corporate debt is enabling riskier companies to raise much-needed cash while fueling debate over whether investors have grown overly optimistic about the economy.
⇑⇓ Start Trading Now or Try a FREE Demo Account ⇓⇑
From April 13 through Friday, companies such as Ford Motor Co., AMC Entertainment Holdings Inc. and SeaWorld Entertainment Inc. issued a combined $28 billion of speculative-grade bonds, the fourth-largest two-week total on record, according to LCD, a unit of S&P Global Market Intelligence.
The surge in issuance follows an even bigger boom in new sales of investment-grade bonds, as businesses of all stripes try to stock up on funds to weather a period in which many can expect little to no incoming cash flow. Bond sales have continued despite volatility in oil prices, with investors largely separating the problems of energy companies from those in other sectors.
Speculative-grade companies—which tend to have large debt loads, challenged business operations or both—had gone most of March without issuing new debt, after investors dumped their bonds and potential borrowing costs skyrocketed.
On Feb. 18, the average extra yield, or spread, investors demanded to hold speculative-grade bonds over U.S. Treasurys was just 3.41 percentage points, according to Bloomberg Barclays data. By March 23, it had climbed to 11.0 percentage points. But Monday, it was back down to 7.74 percentage points—still relatively high, but low enough that large numbers of companies can borrow in the market, especially if they back their bonds with collateral.
The yield on the benchmark 10-year U.S. Treasury note settled at 0.610%, according to Tradeweb, compared with 0.655% Monday. Yields fall when bond prices rise.
Along with other assets like stocks, high-yield bonds have been boosted by government and central bank policies. Those include the Federal Reserve’s promise to buy investment-grade corporate bonds and even some lower-rated bonds, provided they were only recently downgraded.
Investors’ analysis of history has also helped. Over the past three decades, high-yield bond investors have been able to generate some of their best returns in the months after large selloffs pushed spreads to about 9 percentage points.
The lesson from that is “you don’t get this opportunity every year, and when you do you’ve got to jump on it,” said Scott Roberts, head of high yield at Invesco Fixed Income.
Improved demand for speculative-grade bonds has already helped some companies.
Prices for Ford bonds collapsed last month when the company shut down car production. On March 24, the company’s 7.45% unsecured bonds due in 2031 traded as low as 62.25 cents on the dollar, according to MarketAxess, translating to a yield above 14%. S&P Global Ratings downgraded the company’s credit rating to below investment grade the next day.
Already wrestling with slowing sales before the pandemic, Ford has estimated it could burn through around $5 billion a month before it gradually restarts production in the second quarter.
The bonds, though, jumped to nearly 90 cents on April 9, when the Fed said it would buy recently downgraded bonds. A week later, Ford issued $8 billion of unsecured bonds, the largest speculative-grade bond sale on record, according to LCD. Its new 10-year bonds came with an interest rate below 10%.
The recent rally in high-yield bonds is part of a broader trend that has lifted the S&P 500 by about 28% since its March lows. As with stocks, however, investors are questioning the durability of the move.
One cause for concern is an unusually large disconnect between what the market is implying about how many companies will default over the next nine to 12 months and what analysts at ratings firms and Wall Street banks are predicting.
According to one model developed by Marty Fridson, the chief investment officer at Lehmann Livian Fridson Advisors LLC and a longtime high-yield bond analyst, the market is currently pricing in a 12-month default rate of 8.1%. A different model produced by research firm CreditSights put the market-implied default rate on Friday at 7.4% over the next nine months.
By contrast, Moody’s Investors Service has forecast a trailing 12-month default rate of 11.8% by the end of the year and 13.1% by the end of next March. Analysts at Goldman Sachs Group Inc. have similarly forecast a 12-month default rate of 13% by the end of this year.
With social and business activity severely restricted across the country, there is little debate about the near-term hit to the U.S. economy. Investors, though, have tended toward optimism about how quickly the economy can recover, with markets consistently rallying on signs that the spread of the virus is slowing or that potential drug treatments are working.
Many economists—and, for that matter, epidemiologists—have been more pessimistic. In their view, the threat from the virus could linger into next year, continuing to depress economic activity and causing bankruptcies and job losses that will further drag on growth.
“My sense is the market is attaching a higher probability to a V-shaped recovery than I would or most economists would at this point,” said Mark Zandi, chief economist at Moody’s Analytics, which produced the economic forecasts underlying the default forecast of its sister ratings firm.
One wild card could be the market’s ability to help create its own reality. The stronger the high-yield market is, the more likely it is that struggling companies such as movie-theater operator AMC will be able to obtain rescue financing, holding down the default rate at least over the near-term horizon.
Still, extending loans to businesses that might otherwise run out of cash isn’t without risk, since adding debt to companies could lead to deeper losses for bondholders if those businesses ultimately file for bankruptcy anyway.
“We don’t know if we are prolonging the inevitable and impairing recoveries at a junior level, or whether we’re providing the Band-Aid to actually get the company through to sustainability,” said Geof Marshall, head of fixed income at Signature Global Asset Management, a division of CI Investments.