Boston - Eaton Vance and its affiliates seek to actively capitalize on opportunities presented by volatile investor sentiment, while ensuring that the portfolio risk profile remains appropriate for the specific strategy. The following are excerpts from a recent conversation with Kelley Baccei, High Yield Portfolio Manager at Eaton Vance Management.
What we are seeing: The US high yield market got off to a slow start in May, but later surged following promising news on initial trials of several experimental COVID-19 vaccines, a rebound in oil prices and the ongoing stimulus from global central banks, with the expectation of more to come. The most recent rally in high yield has been led by the resurgence in some of the higher beta, more cyclical sectors, which have been hardest hit by the global pandemic. The price of oil surged recently as the supply/demand picture improved. On the supply side, we saw global producers take dramatic steps to curtail production, and we have observed a rebound of demand as optimism from improving trends in the pandemic has allowed the global economy to begin reopening.
In the US, the sectors registering the biggest gains in May were energy, automobiles & auto parts, gaming and movies & entertainment, but all sectors had a positive total return. Whether this resurgence can continue is questionable, given the rapid and meaningful deterioration in fundamentals and the uncertain outlook ahead.
US primary market activity remains high, with issuers looking to take advantage of an eager investor base with cash to put to work. We are starting to see at least a temporary shift away from what was a concentration in secured deals used for liquidity toward more unsecured deals used for refinancing — more similar to what we saw before the crisis. Total issuance for the year broke through $150 billion in the first week of June, representing a roughly 30% increase year over year.
What we are doing: We continue to focus on the fundamentals, as we always do, finding good relative value opportunities in the primary and secondary market. However, valuations have tightened significantly since the March highs. The average spread in US high yield ended May at 657 basis points (bps), down from a peak of 1,082 bps in March, but still about 100 bps wide of the long-term average. Relative value opportunities remain, but current pricing is far more efficient and much of the market appears fairly valued given the current catalysts.
What we are watching: We are closely analyzing earnings releases and available forward guidance, while frequently engaging with the senior management teams of our portfolio companies. Earnings trends for many issuers in our universe will likely trough in the next several months, so parsing the issuers whose earnings are inflecting from those that will remain under heightened stress and may not ultimately recover will be critical.
Default activity continued to increase in May. Despite recent positive performance, the energy sector remains under a particularly elevated level of stress. Avoiding distress within the sector will be vital to minimizing down-market capture, while identifying the mispriced bonds among the issuers that ultimately survive will contribute to returns as the market recovers.
Final word: The market appears highly focused on and reactive to positive headlines. Several large, potentially negative catalysts continue to loom and the market appears to be shrugging them off. We expect there will be additional volatility ahead. We are focusing on bottom-up fundamental credit analysis to help our high yield strategy avoid most of this stress while ultimately capturing as much of the eventual upside as possible.