(October 2020)


The high yield bond market is sending some very odd signals. Over the month of September, something highly unusual happened—the most poorly rated bonds outperformed higher-rated ones. The junk bond market as a whole posted a 1% loss in September, but the lowest rung—CCC+ and below—gained 0.4%. According to well-known strategist Marty Fridson, “The market’s message, namely, that risk decreased in the riskiest high-yield bonds while increasing in the least risky bonds, is perplexing … If a weakening of economic prospects caused default risk to increase, then surely the issues most susceptible to default were the most affected”. According to Fridson, what might be happening is that two separate investor groups have settled into the market: “Our notion is that some investors respond to an increase in credit risk by shedding speculative-grade bonds, while others wait for just such opportunities to put money to work … We suggest that the former group dominates the action in the medium-to-upper end of the speculative-grade quality range, while the more opportunistic players exert greater influence on the bottom tier’s behavior.”


FINSUM + Magnifi: This must be the product of unique buying action rather than some distinct underlying logic. The interesting question is whether the pattern will hold. It is not hard to imagine that more conservative investors would stay at the upper tier of high yield and sell when things look riskier, while an entirely different set of investors see increased risk as a buying opportunity.


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