As high-yield bonds have dropped in recent weeks, words like "bubble" and "warning sign" have been thrown around. Some have said the class of corporate bonds, which pay higher yields due to a higher perceived risk of default, is a canary in the coal mine for other asset classes. But Bank of America Merrill Lynch's head of high yield strategy, Michael Contopoulos, says that concerns about the space are unfounded.
For Contopoulos, the recent story in high-yield bonds is a simple one: Spooked retail investors have begun pulling money out at a rapid pace.
"What we've seen in high yield has really been a retail-driven story," Contopoulos said on Thursday's "Futures Now." "There's been a confluence of events, between geopolitical, Fed and media coming out and talking about a leverage finance bubble, and the easing of lending standards, that have instituted some fear in the retail crowd. You couple that with valuations that were very, very rich at the end of the second quarter—I think that's really led to a little bit of retail panic, if you will, although that has subsided over the last few days."
While high yield bonds have bounced back from their lows, retail investors have not stopped fleeing the funds. On Friday, Lipper reported that investors pulled more than $7 billion from high-yield funds and ETFs in the week ending Wednesday, a new record-high outflow.
Still, now that so-called junk bonds have begun to bounce back, "I think you're going to see the high-yield market actually rebound pretty well," he said. "Fundamentals are strong, and they're as strong has they've ever been."
Contopoulos says the fundamentals are supporting the run in the asset class.
"If you look at interest coverage, which is probably the single most important metric in the high-yield market—so the ability of a firm to ultimately make the interest payment on its debt through earnings—it's at all-time-high levels. And this is why companies default, because they can't pay interest expense."
At the current time, "the power of low interest rates and high interest coverage really makes the asset class one that we don't think will experience defaults for the next couple years."
Ultimately, Contopoulos' conclusion is this, "I don't think it is a warning sign for other asset classes."
Of course, not everyone is so sanguine about the outlook for low-rated corporate debt. In fact, one reason retailers got spooked about high-yield bonds may be due to what Federal Reserve Chair Janet Yellen herself said about the high-yield space.
In a June press conference, Yellen implied that the rise in high-yield bonds could be a threat to the financial system.
"I've spoken in recent congressional testimonies and speeches about some threats to financial stability that are on our radar screen that we are monitoring, trends in leverage lending and the underwriting standards there, diminished risk spreads in lower-grade corporate bonds. High-yield bonds have certainly caught our attention. There is some evidence of reach for yield behavior," Yellen said.