Chart of the Week: October 19, 2015

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Recently, high yield spreads have widened from their June 2014 tights to levels not seen since 2012. While some investors may view this as a warning signal, we believe that this volatility has created opportunity. Spread widening began with a widespread sell-off in high yield after Janet Yellen pointed out the very tight level of spreads, and was exacerbated through the end of last year by falling oil prices, which, as shown in the chart of the week, led to both energy and broad sector spreads increasing. Furthermore, 75% of the domestic high yield index is made up of cyclical sectors (including energy), and given that the asset class tends to move with U.S. large cap equity, recent volatility and the risk-off sentiment in markets may have accentuated the energy-led spread widening. Generally when spreads widen it is a result of investors ratcheting up their expectations of default; however, current spreads imply a 6.0% default rate compared to the actual default rate of 2.3% in the last twelve months and an average of 3.9% since 1988. Thus, given our expectations for continued economic expansion in the U.S. accompanied by a rebound in earnings in 2016, coupled with stable high yield fundamentals outside of the energy sector, it appears that investors in the high yield space could benefit from spread compression from current elevated levels.

For the full report, please click on the source link below.

(Source: JPMorgan)

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