Junk-Bond Risk Gauge Jumps as China Meltdown Adds to Energy Rout

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By Sridhar Natarajan & Michelle Davis

Junk-bond investors coming off their first losing year since 2008 are in the crosshairs again, as a stock-market meltdown in China and a plunge in oil prices cloud the outlook for debt sold by the least credit-worthy companies.

The risk premium on the Markit CDX North American High Yield Index, a credit-default swaps benchmark tied to the debt of 100 speculative-grade companies, surged as much as 21 basis points to 516 basis points, rising toward the highest mark in three years. The average borrowing costs for the riskiest portion of the high-yield market surged to 18.4 percent, Bank of America Merrill Lynch index data show, a level not seen since 2009.

“The whole world’s interrelated and you can’t get around that,” said Andrew Brenner, head of international fixed income for National Alliance Capital Markets in New York. “High-yield’s going to be under pressure just because oil’s under pressure. And you’re having this whole risk-off situation.”

The price of crude has plunged 10 percent this week and touched its lowest level since 2009, pushing the relative yield on energy-company debt to more than 13.5 percentage points, Bloomberg indexes show. The industry, which is clocking its worst performance on record, makes up about 15 percent of the junk-bond gauge.

‘Pointing Negative’

“With commodities, there are 10 things that can go right or wrong, and right now almost all of them are pointing negative,” said John McClain, a portfolio manager at Diamond Hill Capital Management Inc., in Columbus, Ohio, which oversees about $17 billion. “You want to avoid land mines in this market. You don’t want to be a hero. It’s not a time to reach.”

The People’s Bank of China cut the yuan’s reference rate against the dollar by 0.5 percent on Thursday, the biggest since Aug. 13, two days after a surprise devaluation. The Shanghai Composite Index tumbled 7.3 percent before trading was halted by new circuit-breakers that some criticized for exacerbating declines. Later, the nation’s regulator said it was suspending the circuit-breakers.

China’s central bank further spooked the market when it announced that foreign-exchange reserves posted the first annual drop since 1992, spurring concern that capital flight from the world’s second-largest economy is accelerating.

Stocks Plunge

The selloff in equities continued around the globe over concern the Chinese authorities are tolerating a weaker currency as the economy is heading for its slowest expansion since 1990. Export data due next week is forecast to show a sixth month of contraction.

“The confluence of China being extremely weak, a worsening commodity story and several geopolitical issues are all weighing on the market,” said McClain.

High-yield debt is still performing better than stocks, according Peter Tchir, head of macro strategy at Brean Capital LLC, a situation that he says may continue in part because new issues are “non-existent” after last year’s junk-bond rout. The high-yield index dropped 4.6 percent in 2015, the first decline in seven years,  Bank of America Merrill Lynch data show.

“Money on the sidelines means the market is well positioned — I think much better than equities,” Tchir said. “So my current call is for credit to outperform equities at the start of the year, and so far, so good.”

The Standard & Poor’s 500 Index dropped 2.4 percent in New York on Thursday to push its decline in 2016 to 4.9 percent, its worst-ever four-day start to a year. The high-yield index declined 0.004 percent this year through Wednesday.

Source: Junk-Bond Risk Gauge Jumps as China Meltdown Adds to Energy Rout – Bloomberg

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