Survey: High Yield Rally May Be Over

According to the latest quarterly survey of the International Association of Credit Portfolio Managers, the high yield rally may have run its course.

Respondents have a neutral approach to the outlook for credit spreads over the next three months, with a large number forecasting spreads would remain unchanged from current levels.

The outlook is sharply different from the previous survey taken in January, when respondents strongly believed spreads would tighten. The latest IACPM Credit Spread Outlook Index is a slightly negative, at negative 3.6, compared to a sharply positive reading in the last survey of 33.7.

“There’s a sense spreads have reached a plateau,” commented Som-lok Leung, Executive Director of the IACPM. “Our members aren’t seeing a reversal but there’s also a view spreads aren’t going to tighten any further.”

The outlook for spreads fell almost uniformly across both investment grade and high yield debt. Not surprisingly, sentiment was more negative in Europe but, nevertheless, the outlook fell in North America and Asia, as well as Europe. The three month credit spread index for North American investment grade debt dropped from 38.8 in January to 4.3 in the latest reading. The three month outlook for investment grade debt in Europe declined from 30.2 at the beginning of the year to minus 12.8.

“In some ways, it’s as if we’re in the fourth quarter of the bull market,” said Leung. “The game isn’t over but we’re looking for a shift and we could be just an event or two away from a reversal.”

The credit outlook survey is conducted among members of the IACPM, an association of credit portfolio managers at 86 financial institutions located in 17 countries in the U.S., Europe, Asia, Africa and Australia. Members are surveyed at the beginning of each quarter.

Survey results are calculated as diffusion indexes, which show positive and negative values ranging from 100 to minus 100, as well as no change which is in the middle of the scale and is recorded as "0.0." Positive numbers signify an expectation for improved credit conditions, specifically fewer defaults and narrower spreads, while negative numbers indicate an expectation of deterioration with higher defaults and wider spreads.

While the outlook for credit defaults over the next 12 months is mixed in the latest survey, the forecast for corporate defaults is decidedly negative. The forecast for corporate defaults deteriorated from negative 10.6 in January to minus 18.1 in the new survey. Not surprisingly, the results continue to be more negative in Europe than either North America or Asia with the index in Europe remaining at minus 43.9.

“The deterioration in the outlook for corporate defaults is at least partially a re-flection of where we are in the credit cycle,” said Mr. Leung. “The period is sustainable for awhile but not forever. Who knows when, but we’re getting closer to the point where corporate defaults will pick up.”

The outlook for retail, residential mortgage and commercial real estate defaults, however, actually improved in the latest survey. The outlook for retail and residential mortgage defaults eased to minus 0.9 from negative 13.6, while commercial retail estate improved from negative 11.5 to minus 0.9. Special factors appear to be at work. Demand for residential housing in the U.S. has picked up substantially, creating better conditions in that market and commercial real estate appears to be benefitting from accommodative policy from the U.S. Federal Reserve.