High-Yield Expert: Market Expects 10% Default Rate In Energy

In a new report, Marty Fridson, CIO at Lehmann Livian Fridson Advisors LLC – a wealth management fund specializing in income investing, focuses on speculative high-yield corporate bonds. Fridson has crunched the numbers and has determined that the market is currently pricing in a 10 percent default rate in the energy sector.

Overall Market

As of October 16, the market has priced in an overall speculative-grade 12-month default rate of 5.5 percent. Fridson pointed out that this rate is much higher than Moody’s base-case forecast of 3.4 percent. He suggested the reason for the disparity is that Moody’s forecasting methodology focuses on the general economic outlook and doesn’t fully incorporate the deep distress that the metals and mining and energy sectors are currently under.

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Sector Analysis

At the sector level, Moody’s is calling for 12-month default rates of about 5.0 percent for metals and mining and 3.5 percent for energy. According to Fridson’s Distressed Default Rate methodology, both of these numbers are grossly understated. Fridson currently calculates a 12-month default rate of 9.3 percent for the metals and mining sector and 10.2 percent for the energy sector.

“If the market is incorrectly classifying many of those two industries’ issuers as high risks for near-term default, then there are currently many undervalued Metals & mining and Energy issues in the market,” he added.

Discount To Fair Value

Fridson noted that the high-yield market ended the month of September priced below fair value for the first time since June 2013. However, he cautioned investors from drawing broad conclusions about the overall bond market because of the disproportionate amount of distress currently found in the metals and mining and energy sectors.

The SPDR Barclays Capital High Yield Bnd ETF JNK is down 5.4 percent this year.

Disclosure: The author holds no position in the stocks mentioned.