Oil Prices, High Yield and Treasuries
December 15, 2014 | Print View
The price of oil has collapsed the last 5 months from over $100 per barrel in July to $56 per barrel today. OPEC decided not to cut oil production to stem falling oil prices and energy prices continued to decline. Price has dropped approximately 45% in a very short period of time. Look at the chart below highlighting the price of WTI crude oil:
The drop in oil prices is good for consumers (who pay lower prices for gasoline) and the economy overall, but there are ripple effects that may not be so good for investment markets.
Oil producing, oil services, oil infrastructure, and commodity companies are in a flat out bear market due to the drop in energy prices. From their June highs:
- Chevron (a large international oil company) is down 25%
- Schlumberger (the world’s largest oil services company) is down 31%
- Continental Resources (the largest U.S. based shale production company) is down 61%
- Freeport-McMoran (one of the world’s largest mining companies) is down 46%
Energy and commodity related companies make up approximately 15-20% of the S&P 500. In 2015 these companies’ earnings will decline and be a drag on overall earnings growth for the market. See the chart below highlighting the large losses in the oil production sector (blue line), the oil services sector (red line) and the commodity sector (green line):
Another market getting hit is the high yield/junk bond market. The energy sector represents a large chunk of the high yield debt market (around 15-20%) and a sustained drop in oil prices could boost default rates in this sector. As investors sell their high-yield bonds they tend to seek safety in the U.S. Treasury markets. The chart below highlights losses in the high yield market (red line) and gains in the U.S. Treasury markets (blue line):
When the high yield bond market sells off we usually see “credit spreads” widen. A “credit spread” is the difference between junk bond and U.S. Treasury bond yields. Recently junk bond spreads have gone (widened) from 3.5% in June to 5.5% in December. See the chart below highlighting this spread widening:
Put another way:
- High yield/junk bond prices have fallen and yields are now 1% higher YTD
- Treasury bond prices have risen and yields are now about 1% lower YTD
Saving accounts and CD’s currently have very little yield. Many income producing portfolios have turned to alternative asset classes (such as high yield) to produce investment income in the current low rate environment. This additional income doesn’t come without increased risk and lower oil prices are behind the latest downturn. Gradients Absolute Yield and Laddered Income Portfolios have underperformed recently due to lower oil prices and its ripple effects on these higher yielding asset classes.
Nobody likes it when stocks or bonds decline. But remember even though the securities in these income portfolios will go up and down over time, investors will still receive the monthly income they locked into at the time they invested. There may be continued pressure on the oil markets into 2015, but we feel the price of oil (and the high yield market) is in the final innings of their decline.
As of December 15th, 2014:
Dow Jones US Moderately Conservative Index is up 6.50% (TR) for the year
S&P 500 closed at 1,989.63 up 9.98% (TR) for the year
U.S. 10 year Treasury Futures are yielding 2.11% down 0.86% for the year
WTI Crude Oil futures closed at $56.00 down $42.70 for the year
Gold closed at $1,194 per ounce down $10 for the year
To expand on these market reflections or discuss other portfolio strategies please don’t hesitate to reach out to the Gradient Investment team.
