What The High Yield Index Tells Us

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In this week’s episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed What The High Yield Index Tells Us. Here’s an excerpt from the episode:

Tobias Carlisle:
So Dan Rasmussen had a nice tweet where he said, if you watch the high yield spreads, they are often early too big draw downs and then you can take away some guidelines for when the market recovers and so on. So if you watch them, so the high yield spread, you can actually dig this data series up for yourself. It’s available free online. You get it from the Louie fed, St. Louis. How do you say that?

Jake Taylor:
St. Louis.

Bill Brewster:
I think it’s St. Louis. I mean, at least in America.

Tobias Carlisle:
Yeah, that’s my accent. Sorry St. Louis, I’ll get that right next time. I will put this in the show notes as well, so you can look it up yourself, ICEB of A, Bank of America US, high yield index option adjusted spread. So the numbers in … The data series goes back to 1996 and you can see very clearly it blows through. So the numbers to watch is sort of somewhere between six and 8%. When it comes to-

Jake Taylor:
How could you explain what it is? It’s high yield debt minus…

Tobias Carlisle:
Yes, sorry, it’s so it’s the high yielding debt minus the tenure and it just looks at that. So this is the junk spread. This is what leverage borrows typically have to pay. So when these rates blow out, this is often when you see it’s not just equity correction, it’s there’s some underlying problem as well. I think that’s what it sort of demonstrates because they start demanding high yields to underwrite a lot of this stuff. So we saw-

Bill Brewster:
And then just real quick, the OAS is option adjusted spread. So when I was in CFA level two preparation, I could tell you what that means but I’ll tell you now is Google it. It’s the proper one to look at.

Tobias Carlisle:
I did say option adjusted spread, didn’t I?

Bill Brewster:
Yeah, I’m just saying because we had asked what it was. So I was just saying it’s option.

Jake Taylor:
He had to just drop that CFA.

Tobias Carlisle:
What level CFA did they teach you there?

Bill Brewster:
I think it’s two. I think two is the one that you got.

Tobias Carlisle:
There we go.

Jake Taylor:
I’m lashing out because I’m afraid of coronavirus. I’m sorry Bill.

Bill Brewster:
Okay, put your mask on.

Tobias Carlisle:
The only point that I would make about this chart is that it blew up in 1998, blew up in 2007, it blew up in 2011, it blew up in 2016. 2011, 2016 were pretty mild. It only just got to eight in 2011. It didn’t quite get to eight in 2016, but it went through like six pretty in both instances. The 2001 and the 2007 one were very substantial. You can look at it on the chart, you’ll see how kind of how picky it got.

Tobias Carlisle:
So it doesn’t necessarily have to get to that kind of level, but we have gone through six. We went through 6.8 yesterday. We’ve come back a little bit today to 6.38. It’s updated every single day, and it’s very, very steep at the moment. So I don’t know whether that means it’s going to come back down very steeply with we’re at the beginning of something that’s a very violent move, but it’s worth just watching that because it sort of gives you an idea.

Tobias Carlisle:
And when it starts recovering, I think that that’s a pretty good indication that a lot of the underlying credit pain is leaking away. And I would say that’d be close to the bottom for the stock market. It moves all over the place, but it’s just worth watching because it tells you something more than you’re not trying to just pick a bottom in the equity market. You’re looking at the fundamentals of the market too.

Bill Brewster:
And probably come back in when we bail out Shale. I mean how much of that index is Shale? I bet it’s a ton.

Tobias Carlisle:
I have no idea.

Bill Brewster:
I bet it’s a ton.

Tobias Carlisle:
But there’s a lot of energy in there, I’m sure.

Bill Brewster:
Fuck yeah, there is. I mean it’s going to be … The idea that we might bail that out is really funny to me. I mean it’s very infuriating, but it’s also very funny.

Tobias Carlisle:
One of the bio that’s going to Shale and to carnival cruises.

Bill Brewster:
These are the questions that I have as well, sir. They should be going to the service sector.

Tobias Carlisle:
I think either of those things can kind of either we can lose them and we’ll be fine. Sorry to all the shale and carnival cruise goes out there and also the carnival cruise lines are all domiciled offshore and not paying tax in the state. So that kind of excludes your run.

Bill Brewster:
Yeah, the waiters should be cut direct checks. I know it’s hard to do it, but if you want to help people, help the people that are hurt, not over levered billionaire oil people that are hiding in an LLC and levering up like crazy. Get out of here, you can take your loss. I’d be more in favor of removing their limited liability company protections and clawing back their actual personal wealth that I would bailing them out.

Tobias Carlisle:
Well, that should go first before you get the bail out.

Bill Brewster:
Yeah, get out of here with this, but I guess it gets systemic if you have too many debt defaults.

Tobias Carlisle:
But isn’t that what bankruptcy does? It just wipes out the equity, wipes up the next layer until it get to the folks who were lending securely and then they take control of the assets and hand it onto the next entrepreneur who’s got some plan for them. I think that’s a pretty good way of doing it, isn’t it? That’s the fairest way of doing it.

Bill Brewster:
I think you just described capitalism, but unfortunately we sell puts under everything now, so that doesn’t exist.

Tobias Carlisle:
That’s crazy.

Bill Brewster:
It’s insane, terrible policy.

Jake Taylor:
Well, I mean it’s not surprising though. I mean, we have a track record of that now, right? The quickness that they already were talking about it though is what surprises me. Like shit hasn’t even gotten real yet, and they’re already talking about bailing people out. What? I mean I get it. Maybe I don’t get it actually from a long run perspective, but all right, GM, AIG, maybe the banks. Some of these things maybe in 2008 were actually systemic risks-

Tobias Carlisle:
Just to wipe out the equity.

Jake Taylor:
Well, they kind of did with AIG, but to already be talking about that is just to me like you were just telling them like you know what, just keep doing all the dumb things you were doing because we got your back.

Bill Brewster:
I have a soft spot in my heart for airlines, obviously. I would say that that’s actually an industry that I would be okay bailing out given that if we’re saying like-

Tobias Carlisle:
But what level is the pilot coming at? This is my question. Do you buy that the equity holders or do you buy that the airline and wipe out the equity holders? And I say this as an equity holder.

Jake Taylor:
I know, that’s the thing that’s tough about it and I guess … I mean I’ve had this conversation with myself. So I’ve thought like on one hand you have got to at least let the equity holders keep some of it, otherwise you may not get the financing in the future, right? [crosstalk 00:46:01].

Tobias Carlisle:
There’ll be people there. That’s what happens. That’s business.

Jake Taylor:
It’s called progress. You know what I just realized is that we’re all Sears.

Bill Brewster:
What?

Jake Taylor:
I realized that we’re all Sears, we’re all heading towards Sears.

Bill Brewster:
I don’t know, I’m pretty optimistic. I think this is going to be a painful period, but I think we’re all going to get through it just fine.

Jake Taylor:
No, I agree, that’s how I feel about all the serious real estate. It’s just who’s going to be the owner of it may dramatically change?

Bill Brewster:
Well, and that’s the thing about the cruise. Why do you need to bail those guys out? Don’t they have debt holders there? Let those guys fight it out, figure out where the fulcrum asset or whatever is. Just be done with it. So we’re going to write them a check? That doesn’t make sense.

Tobias Carlisle:
All right, a question-

Bill Brewster:
I got a mailbag too.

Tobias Carlisle:
You got a mailbag? Good, you go with your mailbag question.

Bill Brewster:
No, you go ahead because I’ve got to find it.

Tobias Carlisle:
This is from Kevin Marks. This is a tough one, so enjoy this one. Buying a bond is secure, because one can always hold it to maturity. If we’re talking about government back instruments, you can see how that’s a hedge, that’s insurance. So we’re talking about owning TLT or something like this. If you buy a bond ETF, they’re not market driven. Can they not drop like other equities responding to liquidity issues?

Jake Taylor:
Bill I’ll let you handle this easy one. I don’t claim to understand all of the dynamics of some of how these funds work. I’ve heard people talk about how a mismatch in liquidity of the underlying compared to the derivative of it, which is the TLT for in this instance that that could cause serious problems. I don’t quite understand why. I guess you probably just … The price can just move more than you’re willing to imagine when you thought you were buying something very secure. I don’t know what else you guys have to add to that.

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