Two portfolio managers and a strategist argue that the high-yield rally is essentially over, and that the time has come to take some of the chips off the table. The market is priced for perfection, according to Bruce Walbridge, portfolio manager at State Street Global Advisors. "All high-yield market participants are clearly set up for a second half recovery. If it doesn't happen, it may spell a temporary setback," he says. Walbridge believes the economy is on the mend, but wants to be cautious, given a still uncertain environment. "Why are bond yields still going down and stocks going up? It's time to pull in your reins a bit and be sure that you're comfortable with your overall level of portfolio risk," he says. From mid-October of last year through last Thursday, high-yield had total return gains of 25.1%, according to Merrill Lynch data.
State Street has already sold the Six Flags 8.875% of '10 (B2/B). Walbridge notes that the bonds are up some 20 points over the last quarter even though the company has had disappointing results over the last few quarters. It has also unloaded the Avnet
9.75% notes of '08 (Baa3/BBB-) at a price of 114. The issue, which was at par in February, had dropped slightly from its high to a bid of 112 last Thursday. State Street is reevaluating its positions in utilities such as Calpine Corp (B1/BB), Western Resources (Ba2/BB+) and Nevada Power (B1/B+) in the wake of their recent run, as most companies have been able to refinance their bank facilities. "A lot of these were seen as highly at risk. Now that they've fended off their liquidity issues, we have to look at their potential profitability as ongoing entities," Walbridge says.
Investors say they need to look through their portfolios to find credits that have traded through their fundamentals. "You want to look at stuff that's up just on technicals so that you might rotate into something else," says Tom LaPointe, portfolio manager at Columbia Management Group. He declines to say what Columbia is evaluating for sale, though he singles out lodging as one example of a sector marked by struggling balance sheets and strong bond performance. In particular, he points to the Host Marriot 9.5% notes of '07 (Ba3/B+), which were trading at a 105 bid last Thursday.
Christopher Garman, chief global strategist for high-yield at Merrill Lynch, notes that Merrill's statistical model shows that high-yield was over 100 basis points inside fair value at the end of April. He urges investors to trade into higher credit quality issues, noting that low quality assets, especially triple-Cs, tend to underperform from June through November. Triple-Cs are down by nearly 5% on average in the June-November period since 1989, Garman's research shows. By contrast, they have risen some 20% in the December through May period. Single- and double-Bs have also historically underperformed during the six month period through November, though less dramatically. Triple-B's, however, which represent the lowest-tier of investment-grade, tend to perform better at the end of the year, according to Garman's analysis.
