As we reported at the time, back in March in what was the first shot across the junk bond bow, Goldman downgraded the weakest cohort of high yield, CCC-rated bonds, to underweight from neutral and upgraded BB-rated bonds to neutral from underweight, while keeping an overweight recommendation on the “median”, or B-rated bonds.
As shown in the exhibits below, and as Goldman’s chief credit strategist Lotfi Karoui admits, the performance of said rating allocation has been rather mixed.
As Goldman further writes, in some semblance of normalcy and logic, while CCC-rated bonds have underperformed their beta to both B and BB-rated bonds, B-rated bonds have been steadily underperforming their BB peers since mid-May. More granularly and as shown by Exhibit 3, the single B bucket has also accounted for the largest share of bonds that has suffered price declines of more than 5% since mid-May.
Conversely, single-Bs have also accounted for the smallest share of bonds that had more than 5% of price appreciation over the same period. The underperformance of B-rated bonds within the largest movers since mid-May, both up and down, reflects the growing fundamental challenges in many large capital structures in the Wirelines, Media, Energy, and Retail sectors.
So nearly half a year after its last rating revision in the sector, overnight Goldman’s Lotfi Karoui has once again revised his outlook on what has been on of the biggest winners from central bank intervention in capital markets, namely the junk bond space, and has turned even more bearish on the lower quality segments while boosting its outlook for near-IG paper, to wit: “shifting to a more defensive HY rating allocation: Overweight BBs vs. Bs and CCCs. We upgrade BBs to overweight from neutral, downgrade Bs to underweight from overweight, and maintain our underweight recommendation in CCCs.”
What is more notable, is that as justification for his bearish shift, Karoui points out that the fundamentals are starting to get downright ugly:
This allocation reflects a more defensive posture in addition to the lack of fundamental upside for many large B-rated issuers. For CCC-rated bonds, we continue to think the high exposure to secularly challenged sectors coupled with limited scope for fundamentals to improve still warrant an underweight allocation.
Why does this matter? Because for the past 18 months, or since the ECB launched its CSPP corporate bond monetization program, fundamentals have not mattered as investors snapped up any piece of paper, the worse the better, frontrunning the ECB’s own efforts to push up junk prices to record levels. But between the ECB’s upcoming tapering, and today’s Goldman recommendations, fundamentals – that anachronism that was obviated by nearly a decade of direct central bank intervention – may once again matter.
Here are the details:
Turning more defensive across the HY rating spectrum: Overweight BBs, underweight Bs and CCCs. We upgrade BB-rated bonds to overweight from neutral, downgrade Bs to underweight from overweight previously, and maintain an underweight recommendation on CCCs. This allocation reflects a more defensive posture in addition to the lack of fundamental upside for many large B-rated issuers. For CCC-rated bonds, we continue to think the high exposure to secularly challenged sectors coupled with limited scope for fundamentals to improve still warrant an underweight allocation.
For context, Retail and high-cost Energy and Metals and Mining companies account for roughly a little less than a quarter of the combined market value of the CCC bucket (inclusive of non-index eligible bonds). We would however emphasize the holistic nature of our cautious view, which ignores potential opportunities at the issuer-level.
No matter the reason behind Goldman’s cold feet, investors are still clearly living in a world in which central bankers have it all under control as the latest Barclays aggregate HY Corp yield index shows…