Torsten Asmus
By Michael Keegan
In our view, increasing valuation dispersion in U.S. high yield sectors is creating opportunity for active managers.
With all of the volatility in financial markets this year, one might expect dispersion across sectors within the high yield market to be near all-time highs. However, it currently only sits near the midpoint of its historical range. Sector dispersion, defined here as the percentage of sectors trading outside of 100 basis points of the overall market, was near all-time lows in the first quarter as less than 1% of the market was trading outside of this range. After the initial stages of the Ukraine crisis and amid the Federal Reserve’s aggressive hiking cycle, sector dispersion is now at 41%. During periods of market dislocation in the past, this figure has reached as high as 90%. We think dispersion among sectors should continue to increase, which is likely to allow for active managers to deliver outsized alpha potential with differentiation among expected outcomes across the market that have not been present over the past couple of years.
Sector dispersion can come from a variety of places. The past two peaks (2020 and 2016) were led by energy, whereas this sector is much healthier today, populated by high-quality fallen angels from the COVID downgrade wave and supported by a strong commodity outlook. The global financial crisis was led by financials and autos trading significantly wider, and tech/telecom was the driver of dispersion in the early 2000s. At their peaks, these sectors were 1,000+ basis points wide of the overall market. Today, the widest trading sectors are about 200 bps wide of the overall market.
Healthcare has been one of the leaders of the uptick in dispersion this year, for example. Typically considered a defensive sector, it is now struggling with labor inflation issues and leveraged balance sheets in certain pockets. Bottom-up research can inform sector views, and we could see certain sectors separate from the market in a more material way than they have in the past. We also see this differentiation theme playing out when looking at cyclical versus noncyclical sectors. Currently, noncyclicals are trading 48 basis points wider than cyclicals – near the highest levels of the past five years. We see the opportunity to swap into the more defensive cohort at attractive levels. In our view, active management will be necessary to take advantage of these opportunities both across sectors and within sectors as we navigate this period of rising market uncertainty.
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