(Bloomberg) -- Corporate bond investors only seemed to worry about coronavirus for a few days. They may not be paying enough attention to a real threat, some money managers say.
The U.S. high-yield corporate bond market rose this week, generating about 0.63% of gains through Thursday’s close, and risk premiums on investment-grade debt tightened. The stock market also gained. The rally may be a resumption of the market’s strength at the beginning of the year, when average yields reached their lowest levels since 2014.
But in late January, credit markets looked a little more fragile as investors fretted about how the epidemic might affect global growth and demand for oil. Other markets appear to remain concerned: U.S. leveraged loan total returns, for example, have been falling since Jan. 23, and investors yanked $487 million from funds that buy the debt in the week that ended Wednesday.
Steven Boothe, a high-grade portfolio manager for T. Rowe Price, said that even before the epidemic began, investors were wary about the sustainability of global growth, and those fears could be exacerbated now.
“The market was starting to question that,” Boothe said. “The virus gives another excuse to focus on potential weaknesses or fragile aspects of the potential recovery.”
Read More in This Week’s Credit Brief: A Viral Threat
The virus’s effects on junk-rated credit in particular may be outsized thanks to energy companies’ growing presence in the bond markets. Around 12% of the high-yield bond market is made up of energy debt, up from about 4% in 2003 when the SARS outbreak occurred.
Asia’s demand for oil has plunged in the wake of the epidemic, sending West Texas oil prices tumbling to around $50 a barrel, a level where some junk-rated energy companies struggle to generate cash. BP Plc said the coronavirus outbreak threatens to wipe out a third of global crude demand growth this year.
“I don’t think we’ve seen enough weakness to add to high-yield at this point,” said Matt Kennedy, a portfolio manager at Angel Oak Capital Advisors. “It might be a little early to have a good understanding of what the ultimate impact would be on the high-yield space.”
There are signs the virus could strain companies further. Apple Inc. -- which gets about a quarter of its operating income from China -- is temporarily shuttering offices, stores and contact centers in mainland China. Casinos in Macau, the world’s biggest gambling hub, are closed for more than two weeks as China attempts to contain the virus, an unusual step for the nation.
‘Potential Weaknesses’
Risky U.S. energy companies in particular were already hurting before the coronavirus hit. Late last year, nearly a third of high-yield energy notes were trading at distressed levels, and natural gas company bonds fell late January amid mild winter weather and inflated supply. The sector saw 42 producers file for bankruptcy last year, law firm Haynes and Boone said in January.
As China’s presence in the global economy has grown, it’s become a bigger player in the oil markets. Wells Fargo & Co. analysts wrote in a January note that the country demands about 13% of the global oil supply. That buying has now plunged about 20%, Bloomberg reported this week.
In the U.S., high-yield energy companies slumped quickly. Some like Range Resources Corp. and Transocean Ltd. had found receptive buyers for their newly issued debt just weeks earlier. Energy credit tumbled 1.4% through Thursday, while the broader junk bond market has gained 0.66% for the year.
“Energy is a big sector within the market, so it does have an impact on overall returns,” Bloomberg Intelligence analyst Spencer Cutter said, referring to the high-yield market.
Some Pain
Credit markets worldwide are also feeling at least some pain. Euro-denominated company bonds had gained 1.6% in 2020 through the end of January, a figure that has since been pared to 1.2%, according to Bloomberg Barclays index data. Spreads on Asian dollar bonds have reversed tightening from early January, and are effectively back to where they ended 2019.
Not all investors think the doom and gloom will last. Marc Bushallow, managing director of fixed income at Manning & Napier, said he’s expecting the oil slump from the virus to be temporary, and he’s willing to weather short-term stress if it means he can buy energy credit at bargain prices.
“Those lower prices in high-yield we think offer an attractive opportunity to buy some of the names that we like the underlying fundamentals of and are not really concerned about the short-term volatility in,” Bushallow said.
The average speculative-grade bond in the U.S. yielded 5.3% on Thursday, up from around 5% in mid-January, according to Bloomberg Barclays index data. At current levels, high-yield bonds broadly still don’t look like a great buy, said Neil Sutherland, a fixed-income portfolio manager at Schroders.
“We wouldn’t consider this to be a strategic opportunity to allocate large scale to high-yield,” Sutherland said. “It’s certainly more interesting than it was a month or two ago, but it’s still, in our view, not compelling.”
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