Bennett Goodman, Co-Founder of Blackstone’s credit platform GSO, offers his perspective on the recent dislocation in credit markets—and some opportunities it may reveal.
1. With Energy, it’s too early to tell.
Many investors are eager to capitalize on the distress in energy credits today. And potential opportunities abound—energy and commodity companies account for about 25% of the high yield market.i
But the reality is it’s early to say how things will play out. For example, most US operators have a lifting cost today of around $55 a barrel, while the forward curve projects a price of $50 a barrel in 2021.ii
That’s hardly a compelling case for long term investment at the moment.
2. Regulation has created headwinds for credit “technicals,” limiting the supply of capital and creating bottle-necks throughout the system.
The supply and demand dynamic for sub-investment grade credit is dangerously out of joint. Regulatory reforms, including Volcker, Dodd-Frank, and lending guidelines from the OCC have limited participation from historical suppliers of capital including banks, prop desks, CLOs and Mutual Funds. Fact: While junk issuance has doubled over the last 5 years from $1.5 to $3 trillion, available market capital today is down over 80%.iii
3. These forces are creating a compelling opportunity in a particular segment of the market.
The lack of market-making capital I mention above is particularly evident in a sliver of the market—credits rated CCC and B-. Traditional sources of capital for bonds in this range, in particular CLOs, have been less willing to engage. The lack of buyers has led to significant discounts and attractive yields among companies that are otherwise healthy in a moderately improving economy.
4. Compared to equities, junk looks particularly interesting today
Taking a step back, when you look at P/E multiples in equities, high yield may provide an attractive relative opportunity. Valuations across the board in equities are pretty full, particularly after the long beta-driven recovery since the financial crisis. Meanwhile, while much of the distress in credit markets from the first quarter has dissipated, the technicals-driven dislocation outlined above looks more secular in nature. It is depressing the value of certain credits (creating discounts) and pushing up their yields. Only time will tell how long this imbalance will persist.
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i J.P. Morgan High Yield Par Weighted Index as of April 30, 2016.
ii CME Group, Light Crude Oil Futures as of April 21, 2016.
iii J.P Morgan High Yield Annual Review and Bloomberg Primary Dealer Positions.