By
Borsgade
In his recent memo, Howard Marks discuss the current state of the credit market, focusing on high-yield bonds and the implications of narrow yield spreads. Howard emphasizes that while spreads are important, total returns are what ultimately matter for investors. He encourages investors to focus on returns rather than spreads alone when making investment decisions.
Key Takeaways:
Yield Spreads and Credit Risk: Yield spreads reflect investor psychology regarding default risks. Current spreads are historically narrow, around 290 basis points, but Howard argues that historical spreads have been more than sufficient to cover credit losses.
Credit Market Performance: High-yield bonds have delivered strong returns, with the ICE BofA US High Yield Bond Index returning 8.2% in 2024 and 13.5% in 2023. This performance is attributed to increased demand and reduced risk aversion.
Adequacy of Spreads: Howard suggests that today’s yield spreads might be sufficient to offset future credit losses, given improved credit quality and active management strategies. Historical default rates and credit losses support this view.
Contractual Returns: The contractual nature of bond returns ensures that investors receive the expected yield if they hold bonds to maturity, regardless of temporary price fluctuations due to spread changes.
The bottom line is that credit presently offers a better deal than equities (to the extent the S&P 500 is representative of equities), even at today’s spreads. Credit isn’t a giveaway today, but it offers healthy absolute returns and is fairly priced in relative terms.
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Readers are advised that investing may involve a risk of loss that cannot be determined in advance, and that past performance and price development cannot be used as a reliable indicator of future performance and price development. For further information please contact info@borsgade.dk
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