The high-yield market is "approaching a strong technical headwind" and spreads will widen further, said Michael Taylor, high-yield strategist at Bear Stearns. "We've had a correction and there's still more widening to go," he commented, adding he expects spreads to stabilize after hitting around 550bps over Treasuries. The Bear Stearns High Yield Index was around 470bps over mid-week.
Taylor pointed to upcoming supply from fallen angels General Motors and Ford Motor Co. as one factor putting pressure on spreads. "With $200 billion of paper to be downgraded, we're approaching a milestone for the high-yield market, though I don't know that it's one to be heralded," he noted. Fallen angel pressure is more limited outside of the autos, though it may pick up due to leveraged-buyout activities, the strategist added.
Furthermore, while some market participants argue the new issuance lull and the rash of postponed high-yield deals is allowing the market to digest the auto situation, Taylor views the postponements as yet another market negative. "It weighs heavily on those deals. Not that they don't necessarily get completed, but there's still pressure for lower prices and higher yields," he said. Additionally, the ratings upgrade/downgrade ratio indicates credit quality improvement is slowing. And on the demand side, fund flows indicate over $8 billion of outflows from high yield this year and pension funds are also under pressure to reduce their exposure to high yield, he added. "I had gone into the year thinking low single-digit returns, but I think it's going to be a long road ahead," Taylor lamented, noting he expects single- and double-Bs to outperform as investors upgrade their portfolios.
