High Yield

Has it ever occurred to you that buying the dips makes much more sense in high yield than in equities? If you buy a high-yield dip, then the worst case is that you have to hold to maturity in order to realise your return (assuming defaults remain under control, which they have been recently). If you buy an equity dip, the worst case is that you hold forever and never get back to your entry price.

Is this really as obvious as it sounds? Then why doesn’t everybody do it? Is there some reason not to do it? It strikes me that it would be a very good strategy for any vehicle with locked-up capital that can feel happy holding to maturity. The way to build up a portfolio would be to take a bite every time the market sold off — and a bigger bite if it sold off further. If this sounds like dangerous averaging-down, it isn’t — precisely because you can hold to maturity and realise a return even if the market doesn’t recover.

One could try to add some stock selection to this way of doing things, but that strikes me as a bad idea. Why assume one has significant skill in picking high-yield bonds? The obvious thing to do is simply to buy an equally-weighted basket of issues. I wonder whether one can do this in relatively small size.

Reasons to be Cheerful

I have a fairly negative view on markets, and so I am looking for reasons to be cheerful. Two seem pertinent.

First, the Greeks are getting their act together. There is a bit of final wrangling going on about what exactly should fall into the EUR 11.5bn of cuts and what should be dealt with later (PASOK and DL are arguing that cuts to wages, pensions and allowances should be deferred until 2015, while ND wants them to happen sooner) but it looks like specific cuts are going to be agreed. EUR 11.5bn won’t make a massive difference in itself, but it will build confidence with donors and allow the next tranche of aid to be disbursed smoothly. I am not sure that Greece is as “back on the agenda” as I thought last week.

Second, markets have become conditioned to respond to central-bank action and, while I expect that the Fed will not restart QE at the coming meeting and that any ECB action will be small-scale until the ESM is up and running (September or later), some action is possible and even a doveish tone could cause the markets to rally. My feeling is that a lot is already priced in and markets could be setting themselves up for a disappointment, but a) central banks might do more than I expect or b) markets might be happier with mere words than I expect.

Still, I cannot help but think that markets are just in the wrong place. AUD/USD is too high, and so is SPX, given what has changed since they were last at their current levels.

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