2018 is shaping up to be a key year for the high yield bond market. In 2017 the market effortlessly shifted from ‘recovery mode’ (following the 2015/16 shale energy crisis) to rallying in conjunction with the global expansion we see around us. As a result, investors will enter 2018 contending with the offsetting influences of tight valuations against improving macroeconomic – and therefore corporate – fundamentals.
How do we see these competing factors playing out in 2018?
We think the big beta-driven moves of 2016 and early 2017 are behind us. We expect to see a modest amount of yield spread tightening in 2018, but overall we think current valuations are both full and justified.
Investors should remember, however, that the vast majority of returns in the high yield asset class accrue from the compounding effect of high levels of income or carry, through time, and not through the rather more eye-catching beta moves of recent periods.
Furthermore, high yield’s negative correlation with government bond markets leads us to conclude that, in the current improving environment, deriving good levels of income without taking material duration or interest rate risk is very attractive for bond investors.