High yield performance will depend on the economy and the wider market’s risk appetite. The resurgence of COVID-19 warrants some caution but, for those looking towards the longer-term resumption of growth, high yield offers the potential for strong returns in a broader environment of low yields.
Despite some wobbles, markets have been comfortable with their risk-on stance since the start of April, supported by substantial fiscal and monetary stimulus, much of which was aimed at protecting the corporate sector. To a large degree, this support has been validated by the rapid rebound in economic activity data, with the Bloomberg US economic surprise index touching its highest level since February 2018 in early October.
While Q2 GDP numbers were understandably dismal, global growth looks like it reverted to a more normal regime during Q3. There are concerns that the re-surgence in COVID-19 will once again hit growth but risk assets have been buoyed by a distinct political will to avoid another economy-wide lockdown.
This environment has resulted in a substantial move in some of the most risky assets, with option-adjusted spreads (OAS) on the US high yield index moving from over 1300bp, at their most distressed levels, to just under 500bp by mid September. Those riding that wave would have made a return of close to 23%.
The late summer saw spreads re-widening as a second wave of COVID-19 infections swept Europe and given risk events in Q4 2020 — most notably the US election — there will be questions over the degree to which spreads can continue to narrow. While acknowledging the potential for some volatility into the end of 2020, we see several reasons why high yield investments remain compelling.
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