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The January deep freeze in credit markets has begun to thaw, lending support to a nascent recovery in global risk appetite.
After a hostile start to the year for corporate bond issuers, credit spreads have eased back from precarious highs, while several U.S. giants have returned to the debt markets they have so liberally tapped over the years since the financial crisis.
While the potential for the market to react forcefully to the slightest provocation looms over this modest rally, the recent stretch of calm is cause for optimism.
"Once stability comes, fear subsides, short covering happens, then greed comes back," said Tom O'Gorman, director of fixed income at Franklin Bissett Investment Management.
The ability of the markets to weather the oil bust remains a key consideration, and so far, the rot from the energy sector has not spread to non-resource assets to any alarming degree.
For the past year-and-a-half, Canadian bank stocks have been dogged by concerns over potential losses arising from the oil crash.
While recent earnings reports showed the Big Six lenders increasing provisions to cover bad loans to the oil patch, the fallout is manageable as yet, and bank profits were still mostly up last quarter.
"I don't see energy as being systemic," Mr. O'Gorman said. "It's an earnings issue to me, I don't see it as more than that."
If so, the extent to which earnings are insulated should be tested over the next year as more and more energy names are expected to default.
The excess supply of crude oil shows no signs of subsiding soon, giving little hope of crude prices reviving to anywhere near their recent peaks. Earlier this month, Moody's Investors Service downgraded the debt on Cenovus Energy Inc. and Encana Corp. to junk status, as the oil rout tightened its grip on the biggest players in Canadian energy.
But as the pressure rises on energy names, investors have begun to differentiate among sectors in recent weeks.
"There are some indications that markets are beginning to open up, as long as you're not metals, as long as you're not energy," said Geof Marshall, who oversees $10-billion in high-yield bonds for CI Investments.
Before the current respite in the global selloff, pretty much everything was trading in tandem. Whether the catalyst was the slowdown in the Chinese economy, fears surrounding the proliferation of negative interest rates, or fresh negativity over the commodity correction, risk assets of all sorts traded virtually as a single market.
Then, as fear took a breather, several different markets turned positive in unison. On Feb. 11, West Texas Intermediate bounced off of an intraday price of $26.05 (U.S.) per barrel, the S&P 500 hit a low of 1,810, the S&P/TSX composite index troughed at 11,985, and U.S. high yield credit spreads started to decline from a high mark rarely reached.
The market for riskier U.S. debt exploded in the years after the financial crisis as lower-rated companies raised trillions in a welcoming market in search of yield. Ultra-accommodative central bank policy and rock-bottom interest rates encouraged investors to assume risk.
The pace of high-yield deals withered in recent months and practically seized up at times in December and January as risk appetite vanished. Spreads on U.S. high yield bonds over comparable Treasuries more than doubled from mid-2014, peaking at 888 basis points on a Merrill Lynch index of lower-grade debt.
"We're not in this neighbourhood very often," Mr. Marshall said. "This is really only the third time in my career where I've had the opportunity to buy high-yield bonds at these levels."
He said he is not yet at the point where he is jumping back into the market prowling for bargains; he would prefer to wait for confirmation of a bottoming process in U.S. high-yield credits.
High-yield spreads have declined materially over the past two weeks, but remain at levels indicative of extraordinary negative sentiment, which is out of proportion to global economic fundamentals, said Aaron Kohli, a fixed-income strategist at BMO Nesbitt Burns.
"Part of the issue was that it was always a little bit ahead of reality," he said. "I'm optimistic that we've reached a near-term bottom for the meltdown in risk sentiment we've had so far this year."
Blue chip names like Apple Inc., General Motors Co. and International Business Machines Corp., have sold billions in new debt in recent days. But total high-yield sales are running at the slowest pace since 2009, with about $17.7-billion sold so far this year, compared to $45.5-billion at the same point last year, according to Bloomberg.
"If you get a little bit of stability, you'll start to see most credit doing much better, as soon as that global fear impulse has lifted," Mr. Kohli said.
Global economic readings have told little in the way of fundamental deterioration outside of the energy sector, he said. "I think markets are misreading that as a barometer of a much broader global problem."
Any market meltdown inevitably invokes memories of 2008, but the strains that recently arose in the credit market pale in comparison to what dawned on horrified investors back then, Mr. O'Gorman said.
"In 2008-09, the banks had trillions of dollars of assets in derivatives crumbling and the whole financial system potentially coming down with them. Here you have [energy] exposures that are just not that large."
Tim Shufelt