Panel, Conference Presentation
Outlook for High-Yield and Leveraged Finance
Milken InstituteTom Braithwaite, Christopher Boyle, Peter Budko, Henry Chyung, Robert Kricheff, Andrew Whittaker
- The market may enter a period of slow growth and low interest rates, with cyclical sectors like energy, metals, mining, and commodity chemicals facing a risk of downturn and potential defaults, while stable defensive sectors are expected to be supported by the prevailing environment.
- Recent market rebounds are predicted to be technically driven rather than fundamental, representing a "mini-cycle" compressed into four months, with further movements expected to mirror central bank actions and volatility caused by technicals and rate changes.
- High-yield market technicals are expected to remain favorable for the near-to-medium term due to supply lagging behind cash inflows, though extreme central bank activity is predicted to continue favoring levered asset classes to satisfy the global yield requirement.
- Interest rates are predicted to eventually normalize through a choppy path, with negative or low rates currently creating risks of asset bubbles and squeezed bank profits, while a future move away from such rates could trigger an extreme unwind if occurring during economic improvement.
- The credit market is in the late stages of the credit cycle with defaults already increasing, though slow global growth is expected to elongate the cycle rather than trigger an imminent collapse, as the lack of "big booms" outside equities prevents typical "big busts."
- Bifurcation is expected to persist in the high-yield market, with stable defensive businesses facing fewer defaults while cyclical sectors experience elevated volatility and spread widening, particularly regarding downgraded bonds from the metals, mining, oil, and gas sectors.
- E&P is expected to remain a tough asset class with balance sheets running their course despite oil price increases to $45, with companies running negative cash flows and significant leverage making them difficult for distressed investors to avoid, as a bankruptcy wave is not expected to stop simply due to price rallies.
- LBO activity is expected to return as banks move backlog loans from balance sheets, while corporate M&A may displace LBOs as a primary driver, and the hunt for yield is anticipated to bring back appetite for high-quality paper if volatility remains low.
- Fallen Angels are expected to continue outnumbering new issues and distorting the market, with Triple C ratings likely being the last to recover from downgrades despite showing recent signs of improvement.
- Passive management and ETF inflows are expected to increase exposure to fallen angels and commodity risks, creating short-term volatility and magnifying illiquidity as liquidity flows through a narrowing "nozzle" of fewer banks and a shrinking number of Wall Street traders.
- Direct lending by BDCs is expected to fill the financing vacuum left by banks in the middle market, with the industry undergoing consolidation due to too many small public companies in the space.
- Companies are expected to continue relying on financial engineering and low borrowing costs for growth rather than organic revenue expansion, though earnings in the leveraged high-yield space may show real gains for specific companies even if broad macro indicators like GDP appear weak.
- A specific catalyst for the next cycle is predicted to be difficult to pinpoint and potentially exogenous, such as currency devaluations or geopolitical issues, though its impact is expected to be muted by central bank support.
- The energy sector is expected to remain a primary source of defaults, with banks likely becoming less lenient in redeterminations and companies prepared to default if commodity prices move adversely, even if refinancings are attempted during rallies.
- Risk appetite is expected to remain high, potentially elongating the recent risk rally and causing participants to chase assets, including investors piling into energy bonds despite better value and downside protection in non-commodity related bonds.
- The retail sector is expected to face continued challenges due to technology shifts, while a drop in the 10-year Treasury yield is predicted to favor high-yield debt provided it is not recession-induced, as defaults would likely remain low.
- The oil price is predicted to remain impossible to quantify accurately due to non-economic, emotional, and political factors, with passive strategies resulting in increased exposure to volatile commodity risks due to index mechanics.
- Contagion from the energy sector is not expected to cause a broader problem in the high-yield market, with the market expected to see differentiation similar to the dot-com cycle.
- Marginal borrowers are expected to access capital they would not have accessed previously due to technical-driven capital inflows, though liquidity is expected to remain present in volume while price sensitivity may keep long-term capital on the sidelines.