In this video, Palmer Square Executive Director Benjamin Esty looks at long/short credit opportunities in 2016. He begins by assessing the current lay of the land: High-yield bonds are yielding around 9.7%, but excluding bonds issued by commodity-linked firms, the average yield is 8.2%. A year earlier, in spring 2015, the respective yields were 6.5% (overall) and 5.3% (ex commodities). The prior spring, in 2014, both were yielding approximately 5.25%. Thus, credit markets have seen declining prices and rising yields for the past two years, and this is why Mr. Esty thinks credit instruments are “cheap” by historical metrics – so long as we’re not headed into a recession.
The credit markets are indicating a much higher probability of a recession than are the equity markets. As Mr. Esty points out, the S&P 500 is up roughly 2% since June 2014, while the iShares High-Yield Corporate Bond ETF (HYG) is down about 9.8%. In Mr. Esty’s view, this divergence is not warranted, and a recession is unlikely. In response, his firm is engaging in capital structure arbitrage – buying bonds and shorting (or buying puts on) the stock of the same issuers. Other strategies, such as the firm’s fundamental long/short approach, are also explored in this video.
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