Hope sprang eternal during the Pope’s visit to the United States last week. Unfortunately the credit markets did not heed the call. During the first half of the year, investment grade credit spreads widened due to record new issue supply, while sector-specific pain was isolated in the energy and metals space. Up until July, it seemed like if you avoided anything related to China and commodities you were safe. A big change in the market recently has been that the perceived safer sectors and credits have come under pressure and avoiding pitfalls has become increasingly difficult. Instead of a chart this week, the graphic depicted above provides a fitting picture of market dynamics over the last few months.
In the investment grade market, for example, high quality media-related credits widened materially during the third quarter as investors became concerned about the disruptive impact streaming companies like Netflix Inc. are having on the television ecosystem. Next, portions of the stable healthcare sector sold off after Hillary Clinton released a series of proposals to bring down prices of prescription drugs. Finally, highly rated Volkswagen AG disclosed an emissions scandal which sent spreads in the fundamentally sound auto sector wider. These idiosyncratic risks were above and beyond the merger and acquisition activity and record new issue supply that had weighed broadly on spreads over the last year.
In the high yield market the spread widening has been even more pronounced. Aside from energy companies which continue to get punished, a number of credit situations emerged that cumulatively impacted the market. The most significant was the surprise two-notch downgrade of Sprint Corp, the largest issuer in the high yield index. Altice N.V., another very large issuer in the telecommunications and cable space, followed with an aggressive bid for Cablevision Systems Corp. sending bonds sharply lower. In the last week the bonds of two ‘safer’ credits, Valeant Pharmaceuticals International Inc. and Alcoa Inc. also dropped five to ten points as the former was hit by a Congressional subpoena request regarding its drug price increases, while the latter announced a split of the company which negatively impacted credit quality.
Key Takeaways: As more and more companies and sectors succumb to bad news, navigating the market has become extremely tricky. The hope among fixed-income investors is that reduced access to cheap capital will diminish aggressive merger and acquisition activity and debt-financed share buybacks. If management teams focus on balance sheet strength and organic growth, fewer credit blow-ups will occur.
