Aberdeen Asia-Pacific Income Fu Message Board
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Commentary..high yield market
From PHT write up
<<Supply/demand
New issue supply continued to shrink during the
quarter. We have seen about $75 billion of new issuance
year to date in 1999, vs. about $120 billion for the
same period in 1998, representing a 38% decrease. Last
year monthly new issuance averaged $13 billion; so far
this year, it has averaged $8.3 billion. We think
October could be the third consecutive month of issuance
below $5 billion, and could drop as low as $3 billion.
Lower demand from certain segments of the market,
however, has offset some of the beneficial effects of
reduced supply.
Market participants expected a
massive surge of new supply in September and October--as
issuers strove to complete their financing ahead of Y2K
problems--which has not occurred. The market sold down during
July and early August in anticipation of the surge.
Many institutional investors who raised cash during
the sell-off continue to sit on the sidelines. Facing
reluctant, highly selective buyers, many issuers have
re-priced deals to offer higher yields. For example, one
deal in August offered a yield of 10.5% in its
prospectus, but came to market priced to yield 12.0%. Within
two weeks, a similar company offered a yield of
13.25% with equity participation thrown in. Lower
quality deals were pulled off the market. High-yield
rates have risen dramatically since January as a
result.
High-yield mutual funds endured net cash
outflows of about $770 million in August and nearly $1
billion in September.(1) Why the huge outflows? We think
investors are nervous about the default rate, about
potential Y2K problems among issuers and about the overall
negative tone of the bond market.
We have examined
all the companies in the Fund's portfolio, and feel
they are well prepared for Y2K and unlikely to
encounter problems. Harder to know is whether shareholders
will hold or sell.
Default rates
According to the DLJ Default Study, the high-yield default
rate for 1998 was 1.20%. For the 12 months ended
September 30, 1999, the default rate was 3.45%. At the
beginning of 1999, the DLJ high-yield to Treasury spread
stood at 626 basis points, implying a discounted
default rate of about 5.9%. We expect the actual rate to
fall somewhere between 3-4%.
Prices of
high-yield securities tend to reflect potential defaults six
to twelve months in advance. At the end of
September, the DLJ spread had narrowed to 611 basis points,
implying a perceived default rate of about 5.5% for 2000.
We believe defaults are peaking now, and will
decline next year. If correct, our view implies that
current prices are discounting next year's default rate
too heavily, and that there may be upside potential
in high yields.
Valuations
As
measured by the CS First Boston High Yield Index, the
high-yield market lost 1.60% for the quarter, but gained
1.17% year-to-date. High-yield spreads to Treasurys,
average yield and average price all declined. As is
evident in the table below, the market is at one of its
lowest points in recent years.(2)
9/30/99
6/30/99 9/30/98 Avg. since 1/92
(recovery from
last
recession)
----------------------------------------------------------------------
Yield Spread 632 bp 574 bp 691 bp 506 bp
Average
Yield 12.20% 11.45% 11.32% 10.47%
Average Price
$86.12 $89.29 $90.83
$96.03
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In fact, 1999 marks the second straight year in
which high-yield total returns have fallen below coupon
returns--the first time that has happened when the economy was
not in a recession.-
You got that right, foreign capital flow appears
to have been the dominant factor in pricing the long
bond with considerable effects I also think on agency
elgibles (mortgage backeds) over say the last 12-14
months. The million dollar question is how long into the
future will they be subsidizing low rates on our most
conservative debt.
I think the fed is still dominant in
effecting the shorter term rates.
Pseudotsuga, doesn't
that mean something like fake arborvitae? -
There is no simple answer to the possible
evolution of economic growth, interest rates, and
inflation.
What seems to be clear, however, is that the present
trend of accelerating national debt cannot continue
forever. But, as every asset bubble in history proves, it
CAN continue for quite awhile.
We have seen a
bull market built on a number of simultaneous
forces:
1) Demographics. The Baby Boomers are in their peak
productive years. That is a HUGE resource of well-eductaed,
free-thinking workers.
2) Technological revolution.
Computers are revolutionizing everything. The world is
changing MORE rapidly than it did during any of the
previous technological revolutions in human history
(agriculture, printing, industrial). Those took, respectively,
millenia, centuries, and decades to affect the course of
human history, and were separated by the same blocks of
time. Computers brought the rate down to years, and
now, a few YEARS later, the internet has brough it
down to days.
3) The fall of communist and
totalitarian systems. This has created millions of people with
economic wants, and without the economic or societal
infrastructure to produce them. That has created the paradox of
increased consumer demand with simulaneous capital
flight.
4) Secular bear market in commodities. This is due,
in part, to some of the previous forces, technology,
ingenuity of workers, need for cash in cash-starved
economies.
5) Stagnant economies in much of the rest of the
industrialized world. For many reasons, much of the industrial
world's economy has stagnated. Part may be demographic,
regulatory, and cultural differences. Whatever the cause,
this has created an enormous capital flight to the
U.S.
So, we have a combination of forces, some domestic
and some international, that has lured capital, again
both domestic and foreign, in to our equity
markets.
The bottom line is that stock market equity and
foreign bond holders are financing our current accounts
deficits. Foreign money will continue to do that as long as
it is in the best interest of the investors to do
so.
And that requires that:
1) Foreign, and
especially the industrialized countries', economies (and
hence their equity markets) remain stagnant;
2)
Our economy, and especially our currency, remain
strong; and
3) Our equity and bond markets remain
strong.
The bottom line is that our equity and bond markets
are simply FREE MARKETS, governed in large part by
the laws of supply and demand. So long as foreign
money is willing to service our debt, then the present
trend can continue.
But if Japanese, European,
or Russian economies come roaring out of the dark,
then there will be increasing competition for that
investment capital, and European, Arab, Japanese, and Hong
Kong investors, among others, may not find a 6.2%
return on U.S. dollars particularly
appealing.
That, and only that, is what is driving our bond market
down now. And if that trend continues, or accelerates,
then what the Fed does is meaningless. The Fed can
piss whatever interest rate they like in to the wind,
but if no one steps up to buy the 30-year long bond
at the treasury auction, then interest rates will
rise.
And while the magnitude of that increase, and its
effect on inflation and economic growth, are hard to
quantify, the DIRECTION of the effect is crystal clear. -
plays out the way you have outlined it, and I
tend to agree with you, what do you think the FED will
do with interest rates?
I can see two strong
forces on interest rates in the U. S; One strong force
pushing them higher to entice more investment in
government treasuries to service our debt, but another
strong force being the FED to lower interest rates to
pull the economy out of recession.
Am I reading
you correctly that you would predict a stagnant
economy, higher inflation, and higher interest
rates(stagflation) which would continue to be negative for bond
holders as well as turning negative for
stockholders?
Cash would be king again? -
Outlook
If the default rate proves lower
than the market has discounted, then high-yield bonds
could realize greater upside potential. Meanwhile, the
higher coupon rates provide some downside protection. We
think institutional investors will begin re-entering
the market in December, which could spark an early
``January effect''--a surge of buying as managers reset
their portfolios for the coming year. We expect the
market to quiet at year-end, and believe mutual fund
investors are likely to come back in January. With so much
cash waiting on the sidelines, the high-yield market
could be positioned for a significant rally. Of course,
it looked that way last year, too.
Our
outlook for calendar year 1999 calls for gross domestic
product growth of about 3% and inflation around 2%. We do
not see any signs of recession. We expect the long
bond to remain in a 6.00-6.10% range. To sustain a
rally, however, we would have to see Treasury yields
stabilize--if Treasurys continue backing up, the high yield
market will have to back up too.- 1 Reply to flipper_58
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Mr. Flipper_58,
Could you please explain to me
how the following factors affect the NAV of
FAX:
a. Rate of exchange (A$ vs US$).
b. Direction of
interest rates in Australia & in the U.S.
c. Inflation
rates in both countries.
Thank
you,
d_kim_2000
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