High yield is the best short in the market, Bill Gross has been saying, and Asia Unhedged agrees with him.
High yield debt usually tracks three market variables: 1) the oil price (because a large part of high yield issuance is oil-related); 2) the level of stock prices (higher stock prices imply higher capacity to service debt in the future; and 3) stock market volatility (companies with predictable earnings make bondholders happier than companies with uncertain earnings).
During the past three months, the actual level of high yield interest rates (as measured by Bloomberg’s option-adjusted spread, that is, the spread net of prepayment risk) has diverged. Low Treasury and high-grade corporate bond yields have forced yield-hungry investors into high yield. The model says high yield isn’t worth the risk just now.