December 8, 2021 - by Ted Basta. Through the third week of November, loan traders had taken advantage of a softer secondary market and went on to bid up loans to a new pandemic high. But the November ‘buy the dip” rally ended abruptly as news circulated on the new Omicron variant, a fact that rattled markets across the globe. This selloff was then exacerbated by Federal Reserve Chairman Jerome Powell’s new pronouncement on inflation, where he said “it’s probably a good time to retire” the word “transitory” to describe it. Even more troublesome for the markets, he also noted that he expects policymakers to discuss accelerating the timetable for tapering, which would open the door to interest rate hikes thereafter. In the days that followed, investors flocked to safer assets; indeed, Treasuries and high-grade bonds were the only major asset classes to report positive returns in November, up 1.3% and 0.1%, respectively. While loan returns on the S&P/LSTA Leveraged Loan Index (LLI) were in the red, they lost just 0.16% in November, as compared to the 1.02% loss for high yield bonds and the 0.7% loss in equities. The LLI’s market value (MV) return of negative 0.49% though, represented its worst loss since March 2020. The red ink though, would have been more severe if not for these asset classes’ relatively strong performance earlier in the month.
But back in the November secondary loan market, market breadth was decisively bearish as 81% of loan prices declined and just 11% advanced. As risk repriced in the secondary during the last trading sessions of November, volatility spiked, and bid-ask spreads widened by an average of 10 basis points to a three-month high of 76 basis points. In turn, the market’s average bid level sank 40 basis points to 98.14, roughly 50 basis points off its post-pandemic peak, realized just a few weeks earlier. While losses were realized across most of the secondary, they were most severe for lower rated credits, with the CCC sub-index underperforming with a MV loss of more than 1%. At the same time, the high end of the market traded off as well, with the percentage of loans trading at a premium to par falling 14 percentage points to a 12-month low of 6%. From a sector standpoint, many of the largest decliners in November were concentrated in industries hit hardest by concerns over the new COVID-19 variant, led by the airlines.
That all said, the loan market has proven to be extremely resilient since the storied sell-off of March 2020. And so far in December we see no exception. Through the first five trading sessions of the month, prices have already advanced 20 basis points in the secondary with the market’s largest and most liquid loans outperforming the broader market.