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Fridson: With Market Rebound, High Yield Bonds Return To 'Extreme Overvaluation' Status

As we’ve seen, the U.S. high yield bond market has had an impressive rebound of late. That’s good news, right? Yes, but ...

As LCD’s Martin Fridson explains, the recent junk bond run has once again landed the asset class in extremely overvalued territory:

“Between March 15 and April 15, 2016, the option-adjusted spread (OAS) of the BAML High Yield Index narrowed from 684 to 662 bps. Over the same interval, our Fair Value estimate increased from 775 to 794 bps. The net change was an increase in the high-yield market’s overvaluation from 91 to 132 bps. That pushed the degree of overvaluation into extreme territory, which we define as an OAS of at least 126 bps (one standard deviation in our valuation model) tighter than Fair Value.
“That is the bad news.”

There's more, of course, as you have to take the volatile energy/commodities sectors into account here. Fridson:

“The worse news is that to obtain even the meager OAS of the BAML Index, an investor must own a full complement of the distressed commodity industries, Energy and Metals/Mining.”

So, Investors who are wary of undue exposure to the energy and commodities market segments will want to consider how well they are being compensated for the risk of the high yield universe, excluding those buckets. Why? As Fridson explains, that compensation is a ‘whopping’ 232 bps below what investors historically have been paid to own high yield bonds, with risk at present levels.

For more on how Marty determines “Fair Value.”

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This story first appeared on www.lcdcomps.com. It is part of Marty's weekly high yield analysis. LCDcomps.com is LCD's subscription site, offering complete news, analysis and data covering the global leveraged loan and high yield bond markets.

You can learn more about LCD here.

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