(Bloomberg) -- In the 2023 stock market, when one group of companies falls out of favor, another has usually been ready to take its place. The latest winner is firms with the riskiest credit, poised for their best week since January versus their sturdier-balance-sheet counterparts.
The outperformance is happening as credit-market stress eases, helping push the S&P 500 up four of the last five days. It rose 1% Wednesday to fully erase its losses after the collapse of several regional banks three weeks ago.
The sudden popularity of firms with dicey credit is part of a larger pattern in equities this year where harried traders reliably find new vehicles to express bullish views. Past beneficiaries included tech megacaps, cruise lines and, at one point, even banks. The result has been that even as recession odds rise and Federal Reserve policymakers jack up rates, an old strategy — buying the dip — is enjoying by one measure its second-best year in a century.
“Whenever there is any form of crisis, people sell first and ask questions later. In this case they sold off lower credit quality, particularly during the SVB crisis,” George Patterson, chief investment officer at PGIM Quantitative Solutions. “When the panic recedes, then these names often rebound strongly. I’d view the relative performance of this pair as a barometer of how investors are thinking about the importance of credit quality. There is usually an over-reaction both on the way down and on the way up.”
A Goldman Sachs Group Inc. basket of companies with weak balance sheets advanced for a fourth straight session, extending its gain this week to 3.3%. That compared with a weekly return of about 1% for a Goldman basket of companies with sturdy finances.
“Weak areas of the market may be seeing short covering or momentum trading that is looking for quick gains,” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management. “Tightening lending standards will take some time to play out, so in the short-term there can be a lot of whipsaw action as traders position too far in one direction or another, especially in the face of such negative sentiment.”
The resurgence comes amid mounting signs corporate credit markets that seized up during the banking crisis are starting to heal. Ten companies sold bonds Monday, marking the fastest pace of issuance since Silicon Valley Bank collapsed. Another 10 deals went to market Tuesday. US high-grade sales prior to this week had totaled just $76 billion in March, about half the projected pace for the month.
The freeze in the high-yield primary bond market also showed signs of thawing, with one issuer pricing a deal Tuesday at terms that indicated demand still remains intact. The offering was the first since March 2 in the junk-bond market.
“Investors are encouraged by a few days in which no new significant banking related contagion is emerging,” said Que Nguyen, chief investment officer of equity strategies at Research Affiliates. “Markets had been pricing in an eventual Fed pause or easing which reduces pressure on debt-dependent companies, allowing for speculation to the upside.”
To be sure, the rebound may be nothing more than a temporary risk-on move that is lifting large sections of the market. For bulls, the good news is, big money managers who have slashed equity exposure and raised cash holdings appear to be looking for opportunities to put that money to work.
The fear of missing out on the next big rally is leading to a replay of the dip-buying impetus during the 2020 bull run. The S&P 500 has gained an average 0.3% following any down days this year, on pace for the second-biggest rebound in data going back to 1927.
Still, at 4,028, the S&P 500 has not strayed far from the midpoint of this year’s trading range. To Andrew Adams at Saut Strategy, it’s too early to become an aggressive buyer despite the resilience equities have put on in the face of the banking chaos and Fed tightening. Yet, he’s prepared to change gears should he prove wrong.
“The market has not broken out higher, by any means, but it also has not crashed even though it’s had plenty of chances to do so,” Adams said. “I also firmly believe the market tends to do whatever will surprise the most people to catch them leaning the wrong way. Based on sentiment — both anecdotally and via surveys — as well as positioning, a rally would be the most surprising outcome here.”
--With assistance from Vildana Hajric.
©2023 Bloomberg L.P.