Tuesday, August 7, 2012

The US HY bond market looks overheated

The rally in leveraged finance markets is back on, as investors snap up junk bonds as quickly as they come to market.
LCD: - Price guidance for Iron Mountain’s [records-storage company] 12-year (non-call five) subordinated notes is 5.75-6%, and pricing is expected this afternoon via Morgan Stanley, J.P. Morgan, Bank of America, HSBC, RBS, Scotia, and Barclays, according to sources. The deal has been upsized by $50 million, to $1 billion.
This firm is raising $1 billion of 12-year subordinated (B+/B1) money at under 6%. The firm is rated BB- and is on negative rating outlook. And there is no shortage of buyers for such bonds.

As another indication of an overheated market, shares outstanding of BlackRock's iShares iBoxx $ High Yield Corporate Bond Fund ETF (HYG) hit another record ($16 billion of AUM) as retail inflows accelerate.

HYG shares outstanding  (source: Bloomberg)

HY mutual fund flows have been strong this year as well. The year-to-date net investment in HY mutual funds far exceeds all of last year's inflows and is on target to hit an all-time record by year-end.

Source: JPMorgan

That has driven HY bond yields down to their historical support level.

JPMorgan US HY Index yield (YTW)  (source: Bloomberg)

Such aggressive valuations and tremendous retail participation make this market a prime candidate for a correction. This demand is particularly surprising given the macro backdrop of slowing global demand (with renewed weakness in manufacturing - see below) and unresolved issues in the Eurozone.

JPM Global Manufacturing PMI (source: Markit)

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