Market outlook: Second quarter 2024

02 April 2024 by National Bank Investments
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The high yield bond market opened 2024 in a subdued manner after a strong return in 2023. J.P. Morgan Investment Management Inc., portfolio sub-advisor to the NBI High Yield Bond Fund provides an overview of the last quarter and shares what opportunities lie ahead.

Read the portfolio sub-advisor’s comments for this fund included in the NBI Portfolios and certain NBI Private Wealth Management profiles.

After gaining 13.5% in 2023, as measured by the ICE BofA US High Yield Constrained Index, the high yield (HY) market has had a quiet start to 2024. The market had a gain of 0.3% through the first two months, as spreads have mostly absorbed the move to higher interest rates. Compared to the first two months of 2022 and 2023, HY companies have issued more bonds due to lower borrowing costs and open capital markets. Default rates over the past year are below 2%, and modest distressed debt levels suggest a stable environment. Bonds rated CCC are outperforming higher-rated peers, continuing the trend of 2023

Outlook and Challenges

The high yield market has significantly tightened since October 2023 as per the ICE BofA US High Yield Constrained Index. Bonds rated BB and single-B now have narrower spreads compared to their historical trading patterns, while CCC-rated bonds are closer to their typical trading levels. Any further tightening in spreads is likely to come from the CCC segment. Even though CCC bonds make up only 13% of the market (less than the usual 17%), their performance will heavily influence overall returns due to current valuations. Skilled active managers who pick bonds wisely in this segment should do well, but passive investment in the CCC index may lead to some credit losses.

In the high yield market, there have been eight years with negative returns; seven of them were followed by years with double-digit gains. The year after the strong performance typically sees stable returns. In 2024, starting with a high yield near 8% and a duration of 3.3 (compared to 4.5 in 2022), investors can expect steady returns with relatively low sensitivity to interest rate changes. We at J.P. Morgan anticipate spreads to stay within a certain range throughout the year, and a modest default rate of around 2–2.5%, resulting in a projected return of 6-8% for 2024.

Investment Opportunities

Given the gap between high and low credit quality high yield bonds, we believe there are select opportunities for managers to outperform within CCC-rated bonds. These situations can be complex and carry risk, but they offer double-digit yields, much higher than the market average of nearly 8%. HY has a break-even of more than 230 basis points, which means they can absorb more than a 2% move higher in interest rates and still generate a positive return. Moreover, many high yield bonds are priced below their face value, so there's a chance they could go up in price if they're paid off early or if a better-rated company buys the company.

Fund Strategy

The investment strategy is driven by a fundamental research and bottom-up security selection, with no quality nor duration bias over time. The strategy seeks to identify undervalued securities in the marketplace through fundamental research and relative value analysis, with an emphasis on downside protection.

This flexible approach allows the strategy to shift exposures in response to changing market conditions and is designed to generate excess returns in both up-and-down markets.

Legal disclaimer

The information and the data supplied in the present document, including those supplied by third parties, are considered accurate at the time of their printing and were obtained from sources which we considered reliable. We reserve the right to modify them without advance notice. This information and data are supplied as informative content only. No representation or guarantee, explicit or implicit, is made as for the exactness, the quality and the complete character of this information and these data. The opinions expressed are not to be construed as solicitation or offer to buy or sell shares mentioned herein and should not be considered as recommendations.

NBI Funds (the “Funds”) are offered by National Bank Investments Inc., a wholly owned subsidiary of National Bank of Canada. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus of the Funds before investing. The Funds’ securities are not insured by the Canada Deposit Insurance Corporation or by any other government deposit insurer. The Funds are not guaranteed, their values change frequently and past performance may not be repeated.

The views expressed regarding a company, a security, an industry, a market sector in particular, future events (such as market and economic conditions), a company's or a security's performance, upcoming product offerings or other forecasts are solely those of J.P. Morgan Investment Management Inc. and do not necessarily represent the views of National Bank of Canada and its subsidiaries (the “Bank”). These views are subject to change at any time based on market or other conditions and could cause actual results to differ materially from the ones anticipated by J.P. Morgan Investment Management Inc. The Bank disclaims any responsibility to update such views. They do not constitute recommendations to buy or sell nor investment advice.

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