Tags: Junk | Bonds | Warning | Stocks

Junk Bonds Flash a Warning But Stocks Aren't Watching

Thursday, 11 December 2014 05:57 PM

Perhaps 2014 will go down in history as the year that junk bonds sent a warning signal as oil plummeted and stocks just kept rallying.

Prices on high-yield bonds have declined 2.4 percent this month and 5.7 percent since the end of August, even as U.S. equities have climbed to new highs. The dollar-denominated debt is now yielding the most relative to a comparable measure on the Standard & Poor’s 500 index since 2011.

The divergence may signal junk-bond traders are picking up on a fundamental problem of overvalued energy companies in frothy markets fueled by six years of record Federal Reserve stimulus — and that stock investors should pay attention. While falling oil prices mean consumers have extra cash to deploy elsewhere, boosting the economy, the price plunge may also crimp the capital spending by energy companies that has been a driver of growth in recent years.

“The big question is whether oil’s problems are going to stay local or whether they’re going to spread out,” Michael Shaoul, chief executive officer of Marketfield Asset Management said in a Dec. 9 Bloomberg Television interview. The test will be whether “this big decline in oil really provokes some kind of credit problems in either high-yield energy or in one of the emerging markets.”

Crude oil prices have fallen to the lowest since 2009 as the U.S. produces the most in 31 years at the same time that global growth slows. This has eaten into the values of junk bonds in particular, since energy companies accounted for an unprecedented proportion of that market earlier this year (conversely, it should be noted, their share of the S&P 500 Index has dropped to the smallest since 2005).

Normal Relationship

Speculative-grade notes of energy companies have lost 14 percent since the end of August, dragging down returns of similarly-rated debt.

Dollar-denominated high-yield bonds now yield an average 1.2 percentage points more than the earnings yield on U.S. equities, compared with an average 0.2 percent less than the stocks in the past three years.

Of course, there’s also the possibility that these markets are returning to a more normal relationship, in which speculative-grade debt yields substantially more than equities. During the three years through 2008, the debt yielded an average 3.7 percentage points more than the equities.

Now investors are left to decide whether energy companies are actually going to start defaulting, sending ripples through stock markets that have been remarkably resilient, or if the recent selloff is an overreaction that’ll create buying opportunities.

© Copyright 2020 Bloomberg News. All rights reserved.


   
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Perhaps 2014 will go down in history as the year that junk bonds sent a warning signal as oil plummeted and stocks just kept rallying.
Junk, Bonds, Warning, Stocks
417
2014-57-11
Thursday, 11 December 2014 05:57 PM
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