Systematic insights: High yield and EMD: Holding firm against oil shock so far | Insight Investment

We recently considered if high yield was safer than its reputation implies. So far this year AI disruption concerns and now a global energy shock are providing stress tests for the market.

High yield markets have held up relatively well so far

The conflict in Iran has disrupted 20% of the world’s oil supply by cutting off transit through the Strait of Hormuz (Figure 1). Although the US and Europe are less directly impacted than Asian economies, WTI crude oil futures prices have risen ~60% year-to-date¹.

Figure 1: The global oil shock poses a threat to risk assets²

Nonetheless, US high yield has been less impacted than investment grade and equity markets on a total return basis so far (Figure 2).

Figure 2: High yield market has been relatively robust so far³

In our view this may reflect investor confidence regarding corporate bond issuers, as well as the high yield market’s relatively low exposure to interest rate risk relative to investment grade markets.

US high yield markets may also have benefited from relatively high exposure to energy markets, at ~11%, versus ~7% for US investment grade and just ~2% for euro high yield markets. Tightening spreads in the energy sector have helped offset spread widening elsewhere (Figure 3). Our systematic alpha models have separately flagged potential value in an overweight exposure to the energy sector (through specific security selection picks).

Figure 3: Energy sector outperformance may have helped the US high yield market absorb the energy shock to an extent⁴

Turning to emerging markets, rates markets are not yet SIGNALING distress

The energy shock has changed the monetary outlook across several economies on inflation concerns. However, despite a high level of demand for oil originating from the Gulf states, Asian rates markets have remained relatively steady (Figure 4).

Figure 4: So far, average Asian rate market movements across the curve have been relatively contained⁵

In our view this partly reflects growth challenges in Asia, including from potential challenges to global demand. The Philippines (excluded from the indices in Figure 4) is a notable outlier, given higher external financing needs and weaker balance of payments.

Elsewhere, markets in Central and Eastern Europe have shown a higher level of sensitivity, which we believe reflects their relatively high reliance on energy imports, albeit the impact has not been outsized relative to Western Europe.

We believe the impact on Latin America has been cushioned by a relatively high starting level of yields, albeit divergence across the region is notable. The Middle East and Africa have, in our view, been primarily impacted by their proximity to the conflict.

Over the near term, we have a bias to be defensive on emerging market rates in our systematic emerging market strategies given uncertain and volatile conditions.

Uncertainty may present opportunities

The trajectory of the Iran war remains uncertain, particularly given recent escalation. As such, we will continue to watch markets closely. In our view, high yield (and in many cases, emerging markets) are starting from a position of relative strength. In our view, volatility may create value opportunities across markets, particularly for those able to execute on them systematically and at speed