Within the high yield asset class, the theme remains “risk on” as CCC paper once again outpaced the rest of the credit curve this week.

Demand for the high yield asset class remained robust with this week’s inflow of $1.77 billion; this is the 11^th consecutive inflow, bringing the year-to-date total to $12.6 billion. While the primary market remains open for business, the activity slowed towards the middle of the week and many deals struggled to gain any traction out of the gate. By week’s end, ten deals priced for total proceeds of $4.8 billion.

* Data for the various indexes sourced from Bloomberg.

For instance:

• Jobless claims and unemployment are showing signs of improving, but we still don’t seem to have a handle on just how much of that is actually people getting back to work versus people just giving up after being unemployed for so long and no longer looking for work, and/or unemployment benefits running out.

• Oil is now over $100.  We have spoken at length in the past about how high oil prices are in essence a tax on the consumer, giving them less money to spend elsewhere.  We can’t help but wonder how this will impact consumer spending in the months to come.

• The Greek situation seems to be no closer to an end.  Each day there are new headlines about an inability to get a deal done and concerns now that Greece will face a “disorganized default” come March when they have large bond repayments due.

• Getting to the larger European picture, we are seeing economic contraction.  GDP in Europe fell 0.3% in Q4.  While it is no surprise to see contraction in the likes of Italy, Spain, Portugal, and Greece, we also saw contraction in countries such as Germany and the Netherlands.  We are in a global economy and a huge portion of U.S. companies are multinationals, having sales exposure to Europe.

• While you would think the situation in Greece would serve as a wake-up call to all of the politicians here in the U.S. to address our own overspending and massive deficit, it does not seem to be the case.  Election year rhetoric seems to be overwhelming the ability to get something done on a meaningful way.

• The Fed’s January minutes that came out yesterday indicated that they were considering a new bond-buying program, or another round of QE, to help spur the economy.  If these people, who are supposed to have the best information and be among the brightest economists around, are concerned about the economic outlook enough to consider stepping in yet again to provide some further easing, that should at least get our attention.

• We have always viewed government bond yields as a leading indicator.  Despite the equity rally, we continue to see yields on the 5, 10, and 30-year U.S. government bonds at or near historic lows.  Granted, one can make the case that this can be attributed to the Fed’s stance to keep interest rates low through late 2014 (as we have noted in a prior writing, another indication they are concerned that there will be no quick recovery in our economy).  However, there is still a very strong demand and buyers at these very low yield levels.

• By most measures, this has not been a stellar earnings season.  We have seen companies missing earnings at the highest level since 2009.  Additionally, we saw profit margins take a hit over the past quarter.  While Corporate America has made huge strides in improving profitability over the past several years and is running very lean, it does appear that we may have seen a peak in margins and profitability, as there is little more in the way of costs that can be cut.  If margins are no longer improving, the only way to boost profits is to increase the top line, but with the various overhangs discussed above, there doesn’t seem to be much to drive demand growth.  With equity prices driven by P/E multiples, we believe this does not bode well for equities.

So, as we look at the world and investment opportunities around us, we believe diligence and caution is still required.  Despite what seems to be a one way trade up right now, we are seeing the markets punishing security prices on any sort of earnings miss or change in outlook.  And as we look at our own high yield market, we are exercising that caution and diligence as we actively manage our portfolios and choose the credits in which we will invest.  Despite the strength we have seen in our own market, we do continue to see ample opportunities for investment in the high yield bond space, where we are getting paid for the various risks in front of us.  And with the steady coupon incomes, you don’t have to bet on the market euphoria to continue in order to get a tangible return.

* Data sourced from Bloomberg.

*Data sourced from Bloomberg.

For the day the Bank of America High Yield Index (BAML) returned 0.04%, bringing the YTD total to 3.89%. While spreads were unchanged on the day at 627bps, the yield on the BAML index tightened 4bps to 7.31%.  For comparison the spread and yield on the BAML HY Index were 732bps and 8.29% on 12/31/11, respectively.*

More of the same so far in early trading today: there is still money to be put to work, but it seems as if it’s being done a little more thoughtfully for the time being. The forward calendar is still very much the main focus, but with new issue bonds not performing as well the last couple days, some of the wind has come out of those sails as well.

* Data sourced from Bloomberg.

*Data sourced from Bloomberg.

This company, like Caesars, is attempting to extend the maturities on their debt.  They will most likely get this done as there is appetite for this paper, as the index based high yield ETF’s and mutual funds are taking a lot of new capital in and thus they are forced to buy these names.

If you passed your basic math and logic classes in high school, it seems  that these companies will not grow out of their highly leveraged capital structure.  Given the economy is predicted to grow just between 2 – 3% over the next several years and the consumers that gamble have had much of their home equity and retirement portfolios crushed or job losses, I can’t see new monies flowing into this industry to drive growth.  We recently saw the January gambling stats down 7.2% in Atlantic City.  Did I mention Europe is in recession and Japan’s GDP came in well below expectations?

If you are a gambler, you can place a bet on one of these highly levered names, but the betting line is they face a potential restructuring when the music stops in the credit markets and they are asked to pay their maker—can you say debt for equity swap and a possible haircut thrown in?

I looked at one of the index-based HY ETF’s and it holds thirteen different bonds in this highly leveraged gaming space.

Happy investing.

We saw $1.8billion of money flow into the high yield ETFs and mutual funds this past week.  The massive inflows so far this year have helped fuel a very strong new issue market, with $10.8 billion pricing via 15 deals over the last week.  At this point, there seems to be little in the way of positive technical drivers in the high yield market.

* Data sourced from Bloomberg.

*  All index data and returns sourced from Bloomberg.