Attractive Spreads to Continue
December 6, 1999
High yield spreads are currently at attractive historical levels and probably will remain there over the next several months, according to Bud Hoops, senior vice president and fixed income manager at American Century Investments. As a result, returns on junk paper probably will continue to exceed investors' expectations, he said.
"It's curious: Why have spreads remained wide when the economy is so good, earnings are above expectations and the stock market seems to set a new record every day?" Hoops said.
Hoops made his comments last week in an investor roundtable presentation sponsored by J.P. Morgan.
Since 1997, when spreads averaged 300 basis points above Treasurys, margins have widened considerably. The well-documented effects of the Asian crisis and Russian default sent spreads soaring to 600 basis points in early 1998.
And while analysts acclaimed Asia's quick economic recovery, investors remained cautious - cash inflows into high yield mutual funds have slowed to half of what they were in 1997 and 1998. Compounded by a rising default rate on junk bonds issues and a downgrade/upgrade ratio that has stayed well above two-to-one for most of 1999, spreads remain wide. They have held at 500 basis points over Treasurys for most of 1999.
Despite the possibility that the Federal Reserve may continue to raise interest rates in the coming quarters, "absent a recession, the high yield market is an attractive place for investors in 2000," Hoops said.
Hoops said he would continue to invest heavily in telecommunications, favoring names like Qwest Communications, Nextel and Orange PLC, in addition to maintaining significant holdings in cable issuers like NTL and Charter Communications.
Hoops also was positive on the domestic services industry, issuers like Allied Waste, and cyclical paper and forest products names like Gaylor Paper.