There is confusion about the financial market’s performance in 2009 versus that of the “real” economy. We expect that the notion of a “V”-shaped recovery will give way to the understanding that an “L” is the letter representative of the real world. Yet, on the corporate credit side, we are seeing businesses’ margins improving, cash balances increase as companies focus on survival, the new issue market is flowing allowing for additional liquidity, and default rates are expected to plunge over the next few years. We see this as a good environment for high yield investors.
It seems the liquidity rally is near an end. Fundamentals and valuations can be ignored for long stretches, but not forever. Fundamentals of many businesses look to be pressured going forward as sales growth will remain limited and there will be little juice to suck out of margins after this recent cost cutting blitz. We see the ridiculous valuations as a reason to take the chips off the equity table. However, valuations, via spreads, in high yield remain attractive from our perspective.
Once in a lifetime spreads, pent up cash flows combined with a new issue market that had been dormant for months and some hot money chasing it got the fuse lit in high yield in the first half of 2009. While high yield has substantially outperformed in the first half, this is not a reason to celebrate because 2008 is still fresh on our minds. There are several important questions that need to be addressed and lies the market is telling us that need to be understood as investors make decisions. Amidst this backdrop, we see attractive opportunities in the high yield market, especially from the recent wave of secured bond new issuance.
Q1 2009 has been the mirror opposite of Q4 2008, with every asset class riding the wave up. Market participants are grasping on “green shoots” to feed the buying frenzy. However, in looking at equities specifically, we see that as the ultimate delusion. Research has shown that most, if not all, of the returns from equities over the last 100 years were driven by dividends. Yield matters for investors. With equities currently offering very little in the way of yield (dividends), we see corporate debt, with its steady coupon cash flow as a better investment option.