Soaring inflation and supply chain bottlenecks have begun to crack the U.S. $1.5 billion junk bond market as lower-quality borrowers show signs of stress.
Unlike the stock market’s tumble, junk bonds had largely escaped concerns about the US economy, with soaring prices raising costs for businesses. Many bond issuers were strapped for cash because they had locked in low interest rates before the Federal Reserve began to tighten monetary policy, which reassured investors.
This week has shaken investor confidence, forcing a sharp reassessment of the health of the high yield market where lower-rated companies are raising cash.
ATM maker Diebold Nixdorf and pharmaceutical company Bausch Health were among several companies whose debt fell sharply in value after announcing financial results. These moves helped push the broader high-yield bond market to its worst level in 17 months.
“The brutality in the equity market has now extended to high yield,” said John Dixon, high yield bond trader at Dinosaur Financial Group. “[This week] I feel like I’ve been sitting in the spin cycle of a washing machine.
Bausch Health, one of the largest issuers of high-yield bonds in the United States, missed analysts’ earnings estimates on Tuesday, days after the reduced IPO of its eye-care business Bausch & Lomb. Russia’s invasion of Ukraine and China’s Covid-19 shutdowns have exacerbated rising costs for freight, energy and other inputs, said Tom Vadaketh, the company’s chief financial officer.
The company’s $1.25 billion bond due 2028 fell below 60 cents on the dollar, down from around 70 cents at the end of last week and just above 90 cents at the start. of the year.
Also on Tuesday, Diebold Nixdorf’s $400 million bond maturing in 2024, which carries a low triple-C rating, crashed after the company reported weak earnings, dropping to just over 40. cents on the dollar – investors in the territory see it as distressed. It had traded above 90 cents to the dollar just two weeks ago.
“Like many businesses, we faced several challenges in the first quarter related to the global pandemic, the war in Ukraine, rising inflation and uncertainty surrounding financial markets and supply chains. sourcing,” said Octavio Marquez, CEO of Diebold.
The difference in yield, or “spread”, between a widely watched high-yield bond index and equivalent US Treasuries – which isolates the yield investors seek to lend to risky companies – rose 0.59 points percentage to 4.77% this week through Thursday. , compared to 3.10% at the end of 2021.
“That tells you that people are starting to worry about the performance of lower-rated companies in a downturn,” said John Gregory, head of leveraged syndicate at Wells Fargo. “People are becoming increasingly pessimistic about the long-term economy.”
Dismal earnings reports from high-yield issuers remain outliers amid a generally upbeat corporate reporting season. Yet the profit margins of a growing number of healthier businesses are also under pressure as inflation tests the pricing power they enjoyed earlier in the stimulus-fueled pandemic recovery.
The first quarter figures point to a mixed net profit margin for the S&P 500 stock index of 12.3%, according to FactSet. It would be the fifth-highest margin for any quarter since 2008, but half a point below the previous year’s level.
Starbucks was among companies saying its cost inflation had “outstripped” its ability to raise prices. Manufacturers such as Illinois Tool Works and Emerson Electric have also warned of pressure on margins despite their efforts to pass on cost increases to customers.
Bank of America analysts said corporate America had “moderate” margin expectations, while executive comments on earnings calls suggested a sharp drop in business sentiment.
The change has not affected all sectors in the same way. Consumer-oriented companies including Mondelez, Procter & Gamble, Kraft Heinz and Airbnb said their price increases met little resistance. They said they were confident that their wide product lines would allow them to make sales at lower prices if consumers “dropped”.
Other companies said they were seeing signs of consumer fatigue.
McDonald’s said there was no substantial pushback when it raised US prices by 8%, but some lower-income consumers shifted to cheaper items on its menu.
Altria, the maker of Marlboro cigarettes, also predicted that some consumers would prefer cheaper products as inflation put pressure on their discretionary spending.
About 80% of the more than 430 components of the S&P 500 that released first-quarter results beat estimates. Index-wide earnings growth of around 9% was the weakest in more than a year, but was in line with what analysts expected even before the additional disruption caused by the war in Ukraine and the acceleration of the Fed’s interest rate plans. .
However, even companies that reported decent results were not rewarded by investors. According to FactSet, shares of groups that reported a positive earnings surprise fell an average of 0.1% in the days following their earnings reports.
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