Never mind the rising defaults, the struggling energy industry and the battered mutual funds. Junk bonds are poised to gain after their first annual loss in six years, according to credit analysts at some of Wall Street’s biggest banks.
With a late-2015 panic pushing average yields to about 9 percent, the market can absorb an increase in corporate failures while still returning between 4 percent and 6 percent, say strategists at banks from Morgan Stanley to Barclays Plc. The juicy yields will eventually lure investors back into the market after they pulled $5.1 billion in the two weeks ended Dec. 28.
“Risks around the credit cycle have risen, but it is important to focus on what is already in the price,” said Adam Richmond, who heads U.S. corporate-credit strategy at Morgan Stanley in New York. “Even if the cycle has turned and defaults will trend higher over multiple years, high yield can still see a positive return in 2016.”
Their optimism is being supported by U.S. central bankers who’ve dismissed a selloff that triggered an exodus of investor cash and prompted mutual-fund manager to shock investors by freezing redemptions. While Standard & Poor’s projects the U.S. junk-bond default rate will climb to 3.3 percent by September, that’s well below the 12.4 percent peak reached during the financial crisis.
“We think risk takers will come back to retake stock of the opportunities available,” said Eric Gross, who is a part of group of Barclays analysts that forecast gains of as much as 5 percent. “You’re actually getting paid too much in high yield for the fundamental risk."
Richmond estimated speculative-grade debt will gain 5.1 percent this year. Analysts at JPMorgan Chase & Co. projected as much as 6 percent, and as long as defaults hold within their forecast, Citigroup Inc. strategists said they see gains of 5.1 percent.
Of course, much of Wall Street was predicting positive results last year after it seemed that an oil slump was abating and yields recovered from lows touched the previous June.
Instead, commodity prices continued to tumble. And then tumbled some more. The crash floored high-yield energy companies and forced losses of as much as 23.5 percent on their bond investors and dragged down the rest of the junk bond market, which declined 4.6 percent, according to a Bank of America Merrill Lynch index.