4/29/2014

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.

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 23rd, 2014. This event has occurred three times since 2004, which all saw a rise in OAS spreads 50 days later byanaverageof+61bps.

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)

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.