The Bull 'n Bear on Howard Marks' Warning
A couple of weeks ago, I wondered aloud whether high-yield bonds really merited their name, writing:
If you want proof that the Fed's interest rate policy is distorting attitudes towards risk, the FT notes that junk bond yields are now at record lows by some measures. Granted, the spread to Treasurys is still twice what it was at the height of the credit bubble, but when Treasury yields are this low, one needs to wonder if it is enough to price junk bonds on a relative basis (i.e. at a spread to risk-free Treasurys). Junk bond investors should ask themselves: Forget the yield on Treasurys, is a sub-7% yield really qualify as high-yield?
I thought I might be on to something when I saw Howard Marks's most recent memo (How Quickly They Forget, May 25), in which he warns that he sees signs that we are starting to get back to some of the practices/ attitudes that were last prevalent during the height of the credit/ LBO bubble. Marks is the head of Oaktree and a hugely successful-fixed income investor. This is what he wrote regarding high-yield:
The yield spread on the average high yield bond is still on the generous side relative to the 30-year norm of 350-550 basis points, a range of spreads that has given rise to excellent relative returns over that period. On the other hand, (a) spreads have fallen back to the normal range from the crisis-induced stratosphere and (b) the lowness of today’s interest rates means that reasonable spreads translate into promised returns that are low in the absolute. The story’s the same for many asset classes.
However, in the very next paragraph, he writes:
I don’t mean to pick on high yield bonds. [...] In fact, high yield bonds still deliver above average risk compensation, and they remain the highest returning contractual instruments and excellent diversifiers versus high grade bonds.
I have to imagine that when he writes "above-average risk compensation", he is assuming an average of expected returns for other aset classes that is artificially low, not a historical average for high-yield bonds, for example (i.e. in other words, high-yield are attractive on a relative basis.)
In any event, the whole memo is really worth reading and, in fact, it is worth following these memos regularly. Howard Marks is one of the whole hands of the investment; he's been around on the merry-go-around and he talks straight and true when all around him are losing their heads. He warned about the credit bubble, so if he seeing signs of the same exuberance today, it's worth at least considering that he might be right (I happen to think he is.)
Finally, I just want to point out a piece of required reading from this week's Barron's: An interview with Dennis Stattman, the manager of the BlackRock Global Allocation Fund. Stattman is a first-rate, value-driven asset allocater and he has the numbers to prove it. Interestingly, he has a position in gold.
Enjoy your day!
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