At least three high-yield strategists are forecasting positive returns for the remainder of the year, in spite of last Wednesday's WorldCom-related sell-off, which caused returns of -4.23%--the worst single-day for returns in high-yield history, according to Mike Taylor, high-yield strategist at Bear Stearns. The month of June was also the worst on record, according to the Merrill Lynch High-Yield Master II, which was down 7.16% through last Wednesday.
Bear Stearns' Taylor says there is reason for optimism because people still believe the economy has turned. "People stay invested if there's money to put to work. Sectors like gaming, energy and homebuilding are still paying their coupons, and generating higher yields than other assets," he says.
Despite the dismal month, Marty Fridson, Merrill's high-yield strategist, says the high-yield market is fairly valued for the first time since January of this year. Prior to last Wednesday, it had been overvalued, according to Merrill's model. Bear Stearns' Taylor has lowered his forecast for returns for the year from 10-15% to the single digits. "It will be tough to do much better, because the issues people have fled to trade so tightly, a lot of the upside is in very volatile and in some cases distressed issues. It's hard to rely on those for your performance," he says.
One of the anomalies this year is that high-yield indices that do not yet include WorldCom such as those of J.P. Morgan Securities and Credit Suisse First Boston, show widely different returns than those of Merrill Lynch, Lehman Brothers, and Bear Stearns, which include the fallen angel.
For the last five to 10 years all the indices have generally shown similar returns on a monthly basis, notes Peter Acciavatti, high-yield strategist at J.P. Morgan. J.P. Morgan's global high-yield index showed a return of just -2.9% for the month of June through last Wednesday--a more than 400 basis point difference from that of Merrill Lynch.
Acciavatti points out that most portfolio managers did not index-weight WorldCom, given its relatively high market weighting. Year-to-date returns for the J.P. Morgan index are 1%, compared to Acciavatti's January forecast of 12-14%. He is now calling for close to coupon-level returns for the second half, leading to full-year returns of 5-6%.
Nonetheless, Acciavatti sounds a note of caution. "This is one of the tougher years to try to forecast due to so many external events. You've got questionable accounting issues and very weak investor confidence. The broader forecast for the economy and the market--those have followed our expectations."