High Yield Outperformed Equities as Spreads Widened
Credit spreads widened by roughly 60% in April as tariff news hit the markets. Even so, since mid-February, high-yield bonds have outperformed the broader equity market. We view this as evidence of the sector’s resilience—and a potential buying opportunity.
It’s true that spreads might widen further. But we don’t view this as a major concern. Today, the elevated yields of high-yield bonds—the result of both higher Treasury yields and wider credit spreads—provide ample cushioning against the negative price effect of further spread widening. Historically, credit markets have tended to rally after a significant equity correction, and when spreads are this wide, conditions would need to deteriorate quickly for high yield not to provide a competitive return.
Investors sometimes wait until spreads are even wider before taking action. That’s rarely the prudent choice, in our view. Not only is timing credit-spread movements virtually impossible, but investors miss out on high-income and return potential in the meantime.
Credit Selection Is Key to Dodging Defaults
A moderate level of tariffs is likely here to stay, which could lead to continued global trade frictions. How these tensions will ultimately play out is difficult to say. Using a conservative, probability-based framework, we believe high yield stands out as one of the best asset classes to navigate any number of growth scenarios.
In this precarious environment, industry and credit selection will be critical. While a default wave is possible, we don’t see that happening outside of the lowest-quality cohorts. We view CCC-rated issues as particularly risky, as they typically see the lion’s share of high-yield defaults. But even bonds rated higher than CCC—especially economically sensitive cyclical credits—can be risky if growth slows and market volatility escalates.
By contrast, high-quality, shorter-duration securities look compelling to us right now. Allocating to shorter-duration high yield exposes investors to less interest-rate risk while offering high levels of income and an attractive risk/reward profile in an increasingly uncertain environment.
Active Management Can Help Manage Risk
With market uncertainty likely to continue, we believe investors should look to active management to navigate today’s unique challenges. Through careful fundamental research, active managers can target sectors that are less susceptible to economic weakness while identifying mispricings.
The adverse effects of tariffs and deteriorating consumer sentiment warrant particularly close scrutiny. Some companies will struggle more than others in the new tariff environment, and with borrowing costs high and trade tensions mounting, the US economy can’t withstand shocks the way it once could. The Fed will have to weigh how much easing is possible if tariffs fuel inflationary pressures in a slower-growth environment.
But as we see it, it’s at times like these that high yield has the potential to outperform other asset classes. For investors looking to rebalance portfolios, we believe high-yield bonds may be a smart way to reduce overall portfolio risk—without sacrificing return potential.
