Bloomberg News

Wall Street Promotes Junk Bonds as Europe Erupts

April 24, 2012

Morgan Stanley headquarters in New York. Photographer: Daniel Acker/Bloomberg

Morgan Stanley headquarters in New York. Photographer: Daniel Acker/Bloomberg

Morgan Stanley (MS:US), JPMorgan Chase & Co. (JPM:US) and Bank of America Corp. (BAC:US) are recommending junk bonds as Europe’s sovereign-debt crisis flares and concern mounts over the strength of the U.S. recovery.

Morgan Stanley said last week that U.S. high-yield obligations were in a “sweet spot” as borrowers cut their debt loads. JPMorgan said junk yields will fall more than half a percentage point by year-end. Bank of America favors debentures rated in the middle tier of speculative grade.

Gains on U.S. high-yield, high-risk bonds, which are little changed since the end of February, are set to accelerate as central banks respond more aggressively to contain Europe’s fiscal imbalances, Morgan Stanley and JPMorgan said. While forecasting the default rate will rise this year, Moody’s Investors Service says the figure will stay below historic averages.

“High yield is still providing attractive spread compensation, even adjusting for defaults relative to higher- quality credit,” Adam Richmond, a high-yield credit strategist at New York-based Morgan Stanley, said in a telephone interview. “Certainly there are growing concerns surrounding Europe. We believe it’s a somewhat different situation this year in part given more responsive central banks globally.”

While the extra yield investors demand to hold U.S. junk bonds rather than government debt has declined 103 basis points this year to 620 basis points, spreads are still up from last year’s low of 452 on Feb. 21, 2011, Bank of America Merrill Lynch index data show. Spreads soared to 910 basis points on Oct. 4, a two-year high, on concern the European crisis would drag the global economy into recession.

‘Still Looks Attactive’

“Relative to other areas to invest in, high yield still looks attractive,” Peter Acciavatti, head of U.S. high yield at JPMorgan, said in a telephone interview.

Elsewhere in credit markets, the cost to protect against a default by Ford Motor Co. (F:US) dropped the most since October after Fitch Ratings raised the automaker’s credit ratings to investment grade.

Credit-default swaps on Dearborn, Michigan-based Ford fell 40 basis points to a mid-price of 265 basis points as of 11 a.m. in New York, according to broker Phoenix Partners Group. That’s the biggest decline since Oct. 6 and the lowest level since March 19, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Fitch raised the issuer default rating of Ford and its Ford Motor Credit unit to BBB-, the lowest investment grade, from BB+, the ratings firm said in a statement today, citing the automaker’s improved liquidity, lower debt and reduced pension obligations.

GE Most Active

“The upgrade of Ford’s ratings reflects the automaker’s significantly improved financial performance, balance sheet repair and product portfolio improvement that have taken place over the past several years,” analysts led by Stephen Brown wrote in the the report.

Bonds of Fairfield, Connecticut-based General Electric Co. are the most actively traded dollar-denominated corporate securities by dealers today, with 123 trades of $1 million or more as of 12:19 p.m. in New York, according to Trace, the bond- price reporting system of the Financial Industry Regulatory Authority. GE Capital Corp. is planning to sell $3 billion of bonds in a two-part offering as soon as today, according to a person with knowledge of the transaction.

Returns Slowing

U.S. high-yield bonds have returned 0.05 percent since Feb. 29 after gaining 5.25 percent in the first two months of the year, more than the 4.38 percent in all of 2011, according to Bank of America Merrill Lynch’s U.S. High Yield Master II Index. Junk bonds, which are rated below Baa3 by Moody’s and lower than BBB- at Standard & Poor’s, lost 7.46 percent in August and September of last year.

Returns are slowing as a backlash in Europe against budget cuts gains momentum and economists forecast growth is slowing in America.

Dutch Prime Minister Mark Rutte offered his cabinet’s resignation amid a revolt against spending cuts. French President Nicolas Sarkozy lost the first round of his re- election bid as the anti-euro National Front won a record share of the vote.

In the U.S., while gross domestic product grew at a 3 percent pace in the last three months of 2011, it will slow to 2.3 percent this year, according to the median estimate of 74 economists surveyed by Bloomberg. Projections for GDP growth this year are slower than the 3.1 percent posted in 2005 and 2.7 percent in 2006 before the recession and financial crisis.

‘Shock Absorber’

While headwinds that will hinder near-term gains for high- yield bonds are growing, the U.S. economy can still act “as a shock absorber, helping to offset the potential impact caused by changing European sovereign conditions,” the JPMorgan analysts led by Acciavatti wrote in an April 20 note to clients.

The JPMorgan analysts forecasted junk yields will decline 56 basis points to 7 percent by the end of 2012.

Returns on junk bonds may reach 6.3 percent for the rest of the year, Morgan Stanley’s Richmond wrote in an April 20 note to clients, as “modest economic growth” pushes borrowers to trim debt levels, default rates remain below 3 percent and investor appetite for higher-yielding assets increases amid a “mild recession” in Europe.

Debt in the B tier of the ratings scale that’s less exposed to the risk of rising interest rates compared with BB debentures and less vulnerable to default than CCC is attractive, Bank of America analysts led by Oleg Melentyev wrote in an April 20 note to investors.

‘Best Asset’

“There are very few places in the fixed-income universe where investors could expect a similar degree of protection,” the Bank of America analysts said of high yield.

While Moody’s raised its year-end global speculative-grade default forecast this month to 3 percent from 2.6 percent after 11 companies defaulted in March, the figures compare with the ratings firm’s long-term average 4.8 percent. The default rate was at 2.3 percent as of the end of the first quarter, up from 1.8 percent at year-end.

“It’s the best asset to hold right now” unless Europe’s crisis creates a “systemic risk,” Kingman Penniman, chief executive officer of KDP Investment Advisors Inc. in Montpelier, Vermont, said of high-yield bonds in a telephone interview. “High-yield is a class that can absorb concerns in interest rates.”

To contact the reporters on this story: Charles Mead in New York at cmead11@bloomberg.net; Heather Perlberg in New York at hperlberg@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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Companies Mentioned

  • MS
    (Morgan Stanley)
    • $35.76 USD
    • -0.37
    • -1.03%
  • JPM
    (JPMorgan Chase & Co)
    • $61.11 USD
    • -0.21
    • -0.34%
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