Stronger-than-expected technical conditions and improving investor sentiment across the capital markets led to a 0.69% return for the S&P/LSTA Leveraged Loan Index in June. The gain reverses May’s 0.68% loss, which was the first month of red ink for the market since November 2011.
The large loans that comprise the S&P/LSTA Loan 100 led the market higher, returning 1.05% during the month. That marks a rebound from a 1.22% decline in May, when investors sold high-beta names to preserve liquidity.
May and June’s mini-correction/recovery cycle leaves the S&P/LSTA Index up 4.54% in the year to date, with the Loan 100 up 4.89%.
With the market rallying, investors regained their appetite for riskier paper. With the exception of defaulted paper – which was dinged by recently bankrupt issuers Houghton Mifflin and Hawker Beechcraft – lower-rated loans outperformed in June after underperforming in May. In the year to date, likewise, returns are higher down the grade.
The market got off to a slow start in June, with returns accelerating as the month progressed. Indeed, the S&P/LSTA Index put up a muscular 0.67% return during the second half of the month after gaining 0.02% from June 1-15.
The rally in the stock market certainly didn’t hurt investor sentiment for loans. Nor did increasing flows of retail money into both loan and bond mutual funds.
Another source of technical power in recent weeks is the fact that CLO market defied expectations – at least for now – and continued to print new deals at a pace unseen since early 2008. Indeed, $4.1 billion of new vehicles printed during the month.
Finally, managers say that interest – and allocations – from pension funds and institutional investors continued in June. Though the numbers are impossible to nail down, managers describe the dollars involved as in the billions from a combination of loan-only and multi-strategy credit funds.
On the other side of the supply/demand continuum, participants point to the depleted calendar as another prop under loan prices in late June.
The same factors are at work in the new-issue market, where, in late June, clearing yields narrowed and flex activity shifted sharply in favor of issuers.
After the wobbles of late May and early June, the late-month rally has raised hopes that the market has found it legs again and therefore may not be doomed to third successive summer of discontent.
Despite the relief that followed Greece’s mid-June election, which appeared to forestall an exit from the eurozone – and the subsequent market euphoria on June 29, when the S&P 500 rallied 2.5% after the European Council agreed to allow its European Stability Mechanism rescue fund to infuse capital directly into troubled banks – the market clearly is not out of the woods yet.
There is still plenty to worry about, not least of which another flare-up in Europe’s debt drama, which has unfolded steady, and in unpredictable ways, since early 2010. As well, the U.S. recovery has been downgraded by most economists in recent months after a string of less-than-inspiring reports. For instance, S&P’s deputy chief economist, Beth Ann Bovino, in June reduced her forecast for GDP growth to 2% for 2012 and 2.1% for 2013, from 2.1%/2.4% previously.
But let us have our moment. After abiding the choppy market conditions of the late spring, participants are hopeful that the summer months will prove more robust.
Loans versus other assets classes
With the capital markets running in June, loans underperformed equities and high-yield bonds while outperforming high-grade bonds and 10-year Treasuries. That reversed the pattern from May, when the bears were in control and the 10-year Treasury yield touched an all-time low.
In the year to date, meanwhile, loans are only ahead of 10-year Treasuries.
On a risk-adjusted-return basis, loans lag the fixed-income asset classes since the commencement of the S&P/LSTA Index in 1997, but lead equities. That’s no surprise, considering that the 10-year Treasury base rate has fallen from 6.44% at year-end 1996 to just 1.64% on June 29, according to the Federal Reserve.
As mentioned above, the big gainers in June were low-rated high-beta names that bounced back from their May thrashing. The loans that subtracted the most from Index returns in June were led by two recent defaulters, along with a grab-bag of news-driven situations.