Description
Market Observations
December 2015
Calm Broad Market Returns in 2015 Concealed Their Rotting from the Bottom
A market observer looking at the headline performance of various equity or bond indices to date would see what appear to be fairly
calm waters: the S&P 500 is up a few percentage points for the year (notwithstanding late-summer volatility); investment grade
corporate bond indices are essentially flat; and high yield (HY) bond indices have registered low single digit losses1.
Placid surfaces can sometimes hide violent under currents. For example, the 10 largest components of the S&P 500 are up 13% for the
year, masking the average 5% loss for the remaining 490 companies. This dichotomy of performance is hidden from casual observation
due to what we believe is a bias inherent in market-cap weighted indices. The last time the disparity was this large was in 19992.
Similarly, the small loss seen in the HY index3 (down 2.12% YTD) masks the bloodshed in the distressed corner of the market.
The distressed index is down over 31% year to date4. It is curious to hear pundits excited about the high yield index yielding a little over 8% when the distressed index is yielding 21.4%. The third quarter for distressed bonds was worse than any quarter since 20085. We haven’t seen this bifurcation of performance in the equity and high yield markets since the dot-com bust and the great recession, respectively.
Despite the size and scale of these imbalances, they are largely ignored by financial media. Credit Market Underperformance and its Long Term Impact on Equities The obvious culprit in the distressed high yield market looks to be energy and mining companies; however that is not the complete picture. Weakness has spread to companies in technology, media, telecom, and retail. If this trend continues, repricing of capital in the high yield sector will likely mean less cash is available for buybacks and M&A – two drivers of the 6-year bull market for equities.
In fact, we believe the impact of more restrictive capital is already evident in certain sectors of the equity and credit markets, particularly for companies that need to raise capital regularly to finance growth (e.g. REIT’s and MLP’s), but that this weakness remains veiled in the broader averages. The common axiom “A rising tide should lift all boats” assumes all hulls are sturdy. In a healthy market, gains should have some breadth.
Right now, the opposite is occurring in both equity and credit markets while indices remain firm. This presents an interesting and important question: Are These Market Sections Just Lagging the Leaders, or is the Market Rotting from the Bottom up? We believe the end of quantitative easing (QE) is the catalyst for these market dichotomies with only the “weaker/smaller” parts of the market showing the effects thus far. The aforementioned price declines are in the ABSENCE of any major defaults, restructurings, or mass outflows from funds investing in those sectors. With the capital repricing well underway in much of the market, it remains to be seen whether the safe havens in various asset classes will remain immune.
Experience tells us not to expect that, but who knows, maybe this time it’s different. Maybe the top 10 names in the S&P 500 are fairly priced at an average forward PE ratio of 556. Maybe the BB-rated HY index offers value at a 5.77% yield.
Stranger things have happened. For more information on Community Capital Management, please visit www.ccmfixedincome.com or email Jamie Horwitz at jhorwitz@ccmfixedincome.com. 1 Merrill Lynch High Yield Master Fund as of November 30, 2015 Catechism 3 Merrill Lynch High Yield Master Fund as of November 30, 2015 4 Merrill Lynch High Yield Distressed Index as of November 30, 2015 5 Merrill Lynch High Yield Distressed and BB Indexes as of November 30, 2015 6 Bloomberg consolidated estimates by company for AAPL, MSFT, XOM, GE, JNJ, AMZN, WFC, BRK/A, JPM and FB 2 Strategas Research Partners-Market Community Capital Management, Inc. is a Florida-based investment advisor registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Community Capital Management Market Observations– December 2015 p1 .
The distressed index is down over 31% year to date4. It is curious to hear pundits excited about the high yield index yielding a little over 8% when the distressed index is yielding 21.4%. The third quarter for distressed bonds was worse than any quarter since 20085. We haven’t seen this bifurcation of performance in the equity and high yield markets since the dot-com bust and the great recession, respectively.
Despite the size and scale of these imbalances, they are largely ignored by financial media. Credit Market Underperformance and its Long Term Impact on Equities The obvious culprit in the distressed high yield market looks to be energy and mining companies; however that is not the complete picture. Weakness has spread to companies in technology, media, telecom, and retail. If this trend continues, repricing of capital in the high yield sector will likely mean less cash is available for buybacks and M&A – two drivers of the 6-year bull market for equities.
In fact, we believe the impact of more restrictive capital is already evident in certain sectors of the equity and credit markets, particularly for companies that need to raise capital regularly to finance growth (e.g. REIT’s and MLP’s), but that this weakness remains veiled in the broader averages. The common axiom “A rising tide should lift all boats” assumes all hulls are sturdy. In a healthy market, gains should have some breadth.
Right now, the opposite is occurring in both equity and credit markets while indices remain firm. This presents an interesting and important question: Are These Market Sections Just Lagging the Leaders, or is the Market Rotting from the Bottom up? We believe the end of quantitative easing (QE) is the catalyst for these market dichotomies with only the “weaker/smaller” parts of the market showing the effects thus far. The aforementioned price declines are in the ABSENCE of any major defaults, restructurings, or mass outflows from funds investing in those sectors. With the capital repricing well underway in much of the market, it remains to be seen whether the safe havens in various asset classes will remain immune.
Experience tells us not to expect that, but who knows, maybe this time it’s different. Maybe the top 10 names in the S&P 500 are fairly priced at an average forward PE ratio of 556. Maybe the BB-rated HY index offers value at a 5.77% yield.
Stranger things have happened. For more information on Community Capital Management, please visit www.ccmfixedincome.com or email Jamie Horwitz at jhorwitz@ccmfixedincome.com. 1 Merrill Lynch High Yield Master Fund as of November 30, 2015 Catechism 3 Merrill Lynch High Yield Master Fund as of November 30, 2015 4 Merrill Lynch High Yield Distressed Index as of November 30, 2015 5 Merrill Lynch High Yield Distressed and BB Indexes as of November 30, 2015 6 Bloomberg consolidated estimates by company for AAPL, MSFT, XOM, GE, JNJ, AMZN, WFC, BRK/A, JPM and FB 2 Strategas Research Partners-Market Community Capital Management, Inc. is a Florida-based investment advisor registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Community Capital Management Market Observations– December 2015 p1 .
