Along with the rally in equities that we have seen off the February lows, the rally in high-yield debt has been just as impressive. From the lows earlier this year, the Merrill Lynch High Yield Master II index of high-yield debt is up over 12% bringing its total return YTD up to 6.5%. With that rally, spreads have really narrowed falling from 887 bps over treasuries earlier this year to 632 as of Monday’s close.
Obviously, the rally in this area of the debt market has been driven primarily by the rebound in Energy. Since the lows earlier this year, the Merrill Lynch index of high-yield energy has rallied close to 39% for a total YTD return of 12.5%. Over that time, spreads have compressed by nearly half, from just under 2,000 bps above treasuries to 1,064 bps above treasuries through yesterday. To put those levels from earlier this year into perspective, at the depths of the Financial crisis back in late 2008, the spread on the entire high yield master index peaked out at 2,147 bps. In that respect, the Energy sector has gone through its own version of a financial crisis over the last year.
The chart below shows high yield spreads in the Energy sector on a long term basis going back to 1996. As mentioned above, spreads in the sector have nearly been cut in half over the last three months. In order to be fully cut in half spreads would need to narrow an additional 72 bps to 992. Looking at the chart, that kind of narrowing in spreads has been extremely uncommon.