Insight  |  January 16, 2024

US High Yield 2024 Outlook

2023 was a strong year for all asset classes, including US high yield, although it is unlikely that 2024 will be a repeat. The performance run of last November and December brought forward 2024’s return potential, and valuations moved to relatively full status across both equities and fixed income. Much of this rally was driven by the market’s belief that the US Federal Reserve is done hiking (with six cuts coming this year) while sticking a soft landing.  Navigating 2024 will now be more challenging than it was at the end of October. 

Looking ahead, we see several risks and opportunities for the asset class in the coming year.

Opportunities

 MACRO

• The economy is still moving forward, and inflation is abating (6-month annualized core inflation is 1.9%).¹The Fed has an opening to slowly cut rates without stoking inflation or a recession. A ‘Goldilocks’ scenario (not too hot, not too cold) would be positive for high yield.
• The US high yield market is approximately 90% exposed to the US and Canada, the strongest economic block.²

MICRO

• US high yield continues to maintain a high-quality bias with limited CCC issuance.  High risk paper has moved into other asset classes like leveraged loans and private debt.
• The YTW of 7.96%² offers investors a yield that is 50-150 bps greater than the 5, 10, 15, and 20-year averages. 
• Spreads are inside their historical averages but still 50 bps above the post-GFC low and 110 bps above the post-2000 low.  Spreads can compress in a soft landing, low volatility (VIX/MOVE) scenario.
• The average high yield coupon is increasing. During most normal periods coupon income generates 50-100% of an investor’s total return.²
• Default candidates are well known with bond prices well below par. Realized credit losses from defaults will be minimized because of this and should not damage returns materially.
• The DTW of 3.65 years is relatively short and less likely to be impacted by rate volatility compared to higher quality asset classes.  Short duration high yield has approximately two years less duration, further mitigating rate volatility.
• Reallocation to high yield after two years of investors being overweight quality and long duration. 
• Money market assets looking to generate higher returns as the Fed cuts rates.

Risks

MACRO

• A Fed misstep. High inflation or a recession would be challenging for high yield valuations.
• A consumer pullback around a weak jobs outlook.
• Expansion of current geopolitical hotspots and conflicts. 
• Uncertainty about the 2024 election.  This is a short-term phenomenon, although fears around a January 6, 2021, redo could linger depending on the outcome of the election.

MICRO

• Poor technical factors due to hedging costs coupled with fewer net rising stars.
• Investor malaise after the strong performance end to 2023.

Our Strategy

Sector Exposures

Major sector issues seem focused on telecommunications, broadcasting, and healthcare.  Most other sectors either have decent trends or have already experienced contractions and are reverting to norm. Maintain diversification, including energy.

Rating Posture

Maintain exposure to BBs and Bs while minimizing CCCs due to market access concerns.  A balanced approach to BB/B exposure is acceptable given the economic outlook.

Duration Posture

Underweight-to-neutral seems optimal after the fourth-quarter rate rally given the higher-for-longer mantra of the Fed.  Move to neutral-plus on a major repricing of rates to a higher level.

Yield / Spread

Slightly greater than benchmark given continued economic growth.

USD/EUR

Move toward neutral mix from overweight EUR via organic cash flow given the convergence of net yields after hedging.

Bonds/Loans

Maintain exposure to loans given the carry advantage and limited volatility relative to high yield bonds. Follow the economic data and Fed direction and look to reduce loans if the speed of Fed cuts accelerates.

PUTTING IT INTO PERSPECTIVE

It is difficult to predict where markets will move in any given year, but we would like to provide some data about how high yield performs after negative periods like 2022.

Past performance is not a reliable indicator of current or future results.

Source: ICE Data Platform, ICE BofA US High Yield Index, (J0A0), as of 31st December 2023. For illustrative purposes only.  Index performance is for illustrative purposes only. You cannot invest directly in the index.

Several items stand out from this data. 

1.6 of 7 negative return years since 1990 saw multiple years of positive returns before another setback.

2.The recoveries easily covered the drawdowns over the recovery, even after 2008.

3.The annual rate of return typically ebbs as the length of recovery increases.

CONCLUSION

Looking at the asset class’s historical performance leads us to believe that high yield is poised to produce a positive return in 2024, albeit not as robust as that experienced in 2023.  We believe that the economy is not rolling over and that a recession is likely to be at least six months away. Lastly, Treasury volatility is expected to remain elevated until such time as the market is convinced that the Fed is cutting rates consistently and that the economy is not cratering.

Given these assumptions, we believe that exposure to high yield is warranted and investors should aggressively deploy capital during dips associated with either rate increases or risk-off periods.  Such a strategy allows for participation in the asset class if the economy continues to move forward while locking in higher yields and potential capital gains around selloffs. This cycle may prove to be elongated given some of the structural changes due to Covid and yields back to pre-GFC levels due to a higher-for-longer Fed. We are back to being the high yield asset class.

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of January 2024 and may change without notice.

---------------------------------------

Important Information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for a variety of reasons, including but not limited to, increased political, social and economic instability; heightened pricing volatility and reduced market liquidity.

Any research in this document has been obtained and may have been acted on by Muzinich for its own purpose. The results of such research are being made available for information purposes and no assurances are made as to their accuracy. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and this judgment may prove to be wrong. The views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity, they are for information purposes only.

This discussion material contains forward-looking statements, which give current expectations of a fund’s future activities and future performance. Any or all forward-looking statements in this material may turn out to be incorrect. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Although the assumptions underlying the forward-looking statements contained herein are believed to be reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurances that the forward-looking statements included in this discussion material will   prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation that the objectives and plans discussed herein will be achieved. Further, no person undertakes any obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

United States: This material is for Institutional Investor use only – not for retail distribution. Muzinich & Co., Inc. is a registered investment adviser with the Securities and Exchange Commission (SEC). Muzinich & Co., Inc.’s being a Registered Investment Adviser with the SEC in no way shall imply a certain level of skill or training or any authorization or approval by the SEC.

Issued in the European Union by Muzinich & Co. (Ireland) Limited, which is authorized and regulated by the Central Bank of Ireland. Registered in Ireland, Company Registration No. 307511. Registered address: 32 Molesworth Street, Dublin 2, D02 Y512, Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland No. CHE-389.422.108. Registered address: Tödistrasse 5, 8002 Zurich, Switzerland. Issued in Singapore and Hong Kong by Muzinich & Co. (Singapore) Pte. Limited, which is licensed and regulated by the Monetary Authority of Singapore. Registered in Singapore No. 201624477K. Registered address: 6 Battery Road, #26-05, Singapore, 049909. Issued in all other jurisdictions (excluding the U.S.) by Muzinich & Co. Limited. which is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street, London W1S 1YQ, United Kingdom. 2024-01-10-12638