Technicals favour HY versus LCDX, says Goldman

In its 6 February "Credit Line," Goldman Sachs contends that increasing recovery risk and market technicals should favour CDX HY  relative to LCDX. While recovery rates will continue to drop for both bonds and loans, credit strategists note that loans will be affected more adversely than bonds by a potentially unprecedented supply of secured defaulted debt.

Furthermore, increasing numbers of fallen angels could benefit the high yield bond market where a strong investor base could encourage issuance, hence growing and liquefying the secondary high yield bond market.

Significant hedging pressure has caused LCDX to strongly underperform HY over the past few months. Despite the recent rally of LCDX, Goldman is cautious about trading their relative value. Bottom-up analysis shows that tail risk in LCDX is higher than in HY. In particular, the share of secured debt is much larger in LCDX than HY, which translates into higher recovery risk for secured debt and therefore hurts LCDX.