The High-Yield Message The Bulls Ignored In 2007

While high-yield bond yields are at record lows, the spread (or compensation for risk) remains above all-time record lows leaving some to suggest there is room for more compression and for the circus to continue. The credit market’s disconnect from anything macro-, micro-, or cashflow-related (with CCCs now trading sub-7%) is purely a function of flow and yield-grabbing with WACC curves back at 2006 levels…

suggesting little pain for firms willing to relever to recap their shareholders. And so they pay it out… (payouts near record highs)


But there’s no free lunch as credit cycles and the leverage starts to catch up… The gap between the cost of debt and equity is so high that firms have been using balance sheet resources to buy back equity and pay dividends – this has tended not to end well as there is a limit…


In late 2006, the high yield credit market surged ahead of stocks in an exuberant fanfare (heralded by many as the new normal then); it retraced quickly, only to re-accelerate (driven by the vinegar strokes of a CDO rampage) until April 2007 when it once again roared tighter (way ahead of stocks) in a final capitulative fervor.

Fast forward 6 years and in September last year (QE3) HY raced ahead of stocks (only to retrace) and in the last few weeks credit has massively outperformed stocks (selling credit protection has outperformed owning stocks by 4.4% since March 27th) in what feels very capitulative once again.

With the memory of what happened in 2007 entirely priced out of the market as financials and non-financials converge…


Is this melt-up the message most ignored in 2007?


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