High yield bonds should make 14% in 2012, says Morgan Stanley

US high yield should perform strongly in 2012, according to new research by Morgan Stanley, despite the continued weak macroeconomic backdrop. In a strongly bullish Leveraged Finance Outlook for 2012, the bank predicts returns of just under 14% for high yield bonds next year under its base case scenario. Its constructive view is based on strong corporate balance sheets and the view that defaults will most likely stay low. Other more technical factors, such as high volatility and the low absolute level of yields, may limit the scope for spread-tightening, however.

The report notes that once a wave of defaults has rolled through, default rates tend to stay quite low. This supports its view that US high yield defaults next year will remain low, at 2.9% on a base case projection, with 5.5% seen as the worst case scenario.