Perhaps the biggest vote of confidence, though, comes from Bank of America Corp. In an April 26 report, strategists Oleg Melentyev and Eric Yu made a bold proclamation: “A further CCC melt-up still appears inevitable to us.”
Some of the key metrics in the HY market have reached new extremes. The trailing 15-week change in spreads, at -170bps, is among the top 5 historical record moves tighter for this index going back 20+ years. Among the other four instances are the recovery rallies from the depths of 2002 and 2008 recessions as well as the rebounds from the low points of EU sovereign crisis in 2012 and energy meltdown in 2016 ...
The bottom line is that the technicals are too hot at the moment for any of this to matter in the near term, and this understanding stands behind our expectation for a continued CCC melt-up.
So, there are two sides: Those who favor triple-C debt argue that there’s a bit more juice left to squeeze out of this high-yield rally, even if the rebound from last year looks extreme and unsustainable. The bearish strategists are cautious about wading into triple-C debt and break down which kinds of companies make up the index. According to Citigroup, about half is health-care, energy, retail and communications companies — precisely those that have too much leverage or face a much-changed business climate from even a few years ago.
The bears seem to have the better argument. If an investor wants to roll the dice on a further risk-on rally — or a “melt-up” — equities are probably a better way to express that view, even if it’s just for liquidity and diversification. The S&P 500, naturally, has 500 different stocks, while the Bloomberg Barclays triple-C index has just 297 different bonds (the broad high-yield index has 1,921). If one company goes down, the whole index takes a hit.
It just doesn’t seem worth it at this point to take on excessive risk. Using the S&P 500 as a general gauge of risk appetite, it’s telling that as it climbed back toward record highs, investors pulled billions of dollars from equity funds. Relentless selling on the way to the top is a pretty clear sign that people are all too happy to take profits.
In the short term, BlackRock and Bank of America could be right, and triple-C bonds could crack double-digit returns. Junk-bond buyers have been starved for supply, with the volume of debt maturing exceeding the sales of new securities by the most since the financial crisis. Investors just don’t want to be the ones left holding the junkiest bonds when things go the other way.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.