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Aberdeen Asia-Pacific Income Fu Message Board

  • flipper_58 flipper_58 Nov 22, 1999 9:06 AM Flag

    Commentary..high yield market

    From PHT write up


    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

    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.


    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)

    6/30/99 9/30/98 Avg. since 1/92
    (recovery from

    Yield Spread 632 bp 574 bp 691 bp 506 bp
    Yield 12.20% 11.45% 11.32% 10.47%
    Average Price
    $86.12 $89.29 $90.83

    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.

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    • 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

      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

      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

      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

      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

      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

      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

      And that requires that:

      1) Foreign, and
      especially the industrialized countries', economies (and
      hence their equity markets) remain stagnant;

      Our economy, and especially our currency, remain
      strong; and

      3) Our equity and bond markets remain

      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

      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

      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

      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.

      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.

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