Copyright 2014 Arbor Research & Trading, Inc. All rights reserved.
This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in
any form without the prior consent of Arbor. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.
US Corporate High Yield Reaching Extreme Reward / Risk Ratio
U.S. corporate high yield has enjoyed consistent returns with narrowing spreads to USTs since late 2011. Its 25-week
return / standard deviation ratio (i.e. Sharpe Ratio of sorts) has increased dramatically in 2014 relative to European and
Emerging Market high yield and U.S. and foreign equity indices. This pattern is not unusual during periods of positive
returns by risk assets, however elevated reward/risk ratios by U.S. high yield have often been followed by
diminished relative returns to major equity indices and increased volatility.
As our colleague, Howard Simmons, has recently
expressed, U.S. high yield is maintaining its positive
correlation to the MSCI World Index. Both U.S. high
yield and the MSCI World Index have been little
affected since tapering of UST purchases was first
mentioned in May 2013 and later implemented.
Other asset classes like U.S. investment grade and
U.S. treasuries have resumed their negative
correlation in recent months.
4/29/2014
Copyright 2014 Arbor Research & Trading, Inc. All rights reserved. This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in
any form without the prior consent of Arbor. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.
In the chart to the right, we show
spreads of reward/risk ratios to the
MSCI World Index for the following
total return indices: U.S. High Yield,
Investment Grade, U.S. Aggregate
Bond, Emerging Market Sovereigns
and High Yield, European Sovereigns
and High Yield, S&P 500, DAX, and DJ
Commodities. We use a 10-day
average of these values for smoothing.
The maximum and minimum of these
spreads are shown for simplicity with
U.S. high yield removed for
comparison. The reward-to-risk for
U.S. high yield in 2014 has clearly
advanced far and above these
other asset classes under review
relative to the MSCI World
Index.
Most interestingly, U.S. high yields elevated spread to the MSCI World Index of nearly +0.6 has been followed by lower
relative returns to the equity index and increased standard deviation over the following 25 weeks.
Copyright 2014 Arbor Research & Trading, Inc. All rights reserved. This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in
any form without the prior consent of Arbor. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.
The 10day average of U.S. high
yields reward/risk spread to the
MSCI World Index dropped back
below +0.6 on April 23
rd
, 2014.
This event has occurred three
times since 2004, which all saw a
rise in OAS spreads 50 days later
byanaverageof+61bps.
In conclusion, U.S. high yield may be overdue for underperformance relative to equity returns in the months ahead.
History indicates the good times cannot roll indefinitely for U.S. high yield and relative returns are subject to mean
reversion. Additionally, investors should note volatility is likely to increase from what is an extremely low level.
Total return indices reviewed in this study:
Barclays U.S. Corporate High Yield Index Unhedged (USD)
Barclays U.S. Investment Grade High Yield Index Unhedged (USD)
Barclays U.S. Aggregate Bond Index Unhedged (USD)
S&P 500 Total Return Index (USD)
Dow Jones Commodities Index (USD)
Barclays Emerging Markets Sovereigns Total Return Index Unhedged (USD)
Barclays Emerging Markets High Yield Total Return Index Unhedged (USD)
Barclays Pan-European Aggregate Total Return Index Unhedged (USD)
Barclays Pan-European High Yield Total Return Index Unhedged (USD)
DAX Total Return Index (EUR)
MSCI Emerging Markets Total Return Index (USD)
MSCI World Index (USD)