The narrow difference in yields between investment-grade and high-yield paper may prompt companies on the fringe to take on additional debt and lever up in order to boost disappointing equity performances. "This suggests a company can float debt and buy a company because the equity is cheap--that's an argument for leverage right there," explained Chris Garman, head of high-yield strategy at Merrill Lynch, who noted the leverage incentive is traditionally linked to the equity markets. Furthermore, J.P. Morgan this week sent a note to bond investors warning of a disappointing earnings season for the second quarter and growth rate of around 7%, down from the 17% rate registered from the previous quarter, which may increase pressure on companies to increase leverage and take steps that would boost stock prices.
While the spread between double and triple-B bonds is currently around its historical average at 140 basis points, the data is skewed because of General Motors, which is trading like a triple-C credit, noted Garman. Mid-week the average quality of the auto sector in high yield was double-B with an average spread of 458bps over Treasuries. And the spread between single- and double-B credits is unusually tight, around 110bps, according to Merrill.
