High-yield bonds may soon be fairly valued, or even attractive, relative to leveraged loans.
How do we arrive at such a conclusion? In brief, we adjust for differences in the ratings mix between the two asset classes and compare the three-year discounted spread on the S&P/LSTA Leveraged Loan Index and the option-adjusted spread (OAS) on the BofA Merrill Lynch US High Yield Index.
We convert the difference in these spreads into an index geared to one standard deviation from the mean in either direction. A reading of +1.0 indicates that bonds are extremely rich versus loans and a reading of -1.0 indicates that loans are extremely rich versus bonds.
As the chart illustrates, in February, high-yield bonds were extremely rich versus loans. They ceased to be in March, as the reading dropped from 1.1 to 0.6. That trend continued in April, with loans experiencing more spread-tightening than bonds. At month-end the reading stood at 0.25. If the trend continues at its pace of the past two months, high-yield will reach fair value versus loans this month and even become slightly cheap in relative terms. – Martin Fridson
This analysis is part of Marty’s latest weekly commentary, available to LCD News subscribers on www.lcdcomps.com. As well as his weekly write-up, Marty pens a monthly analytical feature on the high-yield bond world for LCD News.
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