Tom and Jerry days

The cat and mouse game has begun.

Discontent seems to be rising in the high yield market after roughly two years of steadily falling credit spreads. People are starting to creep out of the woodwork, squeaking about the unrecognised risks and warning of coming pain. Credit has had a pretty good run since early 2016, but high yield spreads have stepped up noticeably this year. While it’s probably about the right time for this kind of talk, we’re unconvinced that we should be jumping completely out of this space.

Doubt abounds. The Milken Institute Conference, a Davos for financial services held in plush Beverley Hills in early May, was riven with a feeling that we are “in for a 2007 or 1994”. There were discussions about “investors buying stuff without understanding the risks,” and “high yield is in for a hiding.” I have heard all this from news reports – my own invite got lost in the post …

US high yield spreads jumped to 370 basis points in late March and have scurried around between 330 and 350bps since. We are now back, roughly, to where we were a year ago. Yields are still very low compared to the last decade of history. We are a long way from the heady days of 550bps spreads that we saw in early 2016 when global stock markets took a sudden tumble. Back then, investors were worrying about the long-fabled Chinese economic slowdown, sending oil to $28 a barrel and commodity prices slumping. Those fears – while never truly banished – have receded into the background once more. Oil and commodities are at pretty healthy levels once again. One similar factor to two years ago is that strong American economic data seems to be hurting risk prices once again. Whenever a measure overshoots, investors are quicker to worry about rising interest rates than they are to rejoice in a healthy business environment. Good news is bad news.

But, overall, the music just keeps playing and investors keep dancing. Do you get a cab now and miss out all the fun as the party rolls into the wee hours? It’s a hard decision to make. For us, we believe the fixed income market is turning into a bit of a cat and mouse game. Investor mood swings will be just as dangerous as rising default rates, sharper inflation and quicker monetary tightening. We are reluctant to jump completely out of credit risk because economic data looks sound and the strong conditions for corporate debt could continue for some time yet. So it is that we are scurrying round the market a bit, picking up duration or credit when it’s cheap, selling a bit when it’s expensive.

Greater volatility is creating more of these trading opportunities, but it comes with risks. We’re trying to be as cautious as possible: we don’t want to go hungry, but we don’t want to be caught with our back to the wall and a crazy cat in our face.