If there is a parallel between the 1981 high-yield bond market and now, it would be complacency, legendary credit analyst Martin Fridson tells Institutional Investor. Unfortunately, the “subdued default rate” is only fueling that complacency.
Dubbed “the dean of high-yield bond analysts,” in an interview Fridson notes that a low default rate doesn’t guarantee that high-yield bonds won’t drop “more than they did in 1981.” In fact, he says, bond prices often plummet before defaults.
“Bonds that defaulted in 2008 went from par to 70 during 2007,” says Fridson, who currently works as a chief investment officer at money management firm Lehmann, Livian, Fridson Advisors. “People don’t grasp that bonds that default already are at distressed levels in the year before they default.”
Moody’s Investors Service is forecasting a high-yield default rate of 2.5% over the next 12 months. But that could be the proverbial calm before the storm. As Fridson cautions, “the number of bonds trading at distressed levels could rise,” even though that rate is currently very low — under 4%.
Fridson, who started his career at Salomon Brothers more than 30 years ago, doesn’t think high-yield bonds are in a bubble even though he feels they are overvalued. A key reason, he maintains, is because money managers aren’t chasing this market as they did in the 1980s.
Another difference between now and then, according to Fridson, is the abundance of “sell-side research on the high-yield sector.” As Institutional Investor notes, in the 1980s “this market was called junk but Fridson’s research helped establish the legitimacy of high-yield bonds as a major asset class.”
Also, covenants have become stronger and the market has globalized in a way it didn’t back in the era of big hair.
“Even China has high-yield bonds,” Fridson tells Institutional Investor.