Stocks Ignore Bond and Oil Warnings

falling oil prices

Some believe 2014 will be known as the year that warning signs were sent out by junk bonds as stocks continued to rally and oil declined.

This month, high-yield bond prices dropped 2.4% and since the end of August, 5.7%, this as equities for the United States reached record highs. Now yielding the most relative to a comparable measure is denominated debt since 2011 on the Standard & Poor’s 500 Index.

The conflict might be a signal that junk bond traders are picking up on the problem of energy companies being overvalued in markets fueled by six years of record stimulus by the Federal Reserve Bank but also, more attention may be paid by stock investors.

Because oil prices are declining, consumers have more cash on hand for other things, which in turn helps gives the economy a boost. At the same time, capital spending might be hampered by energy companies that in recent years has been the driver of growth.

In a December 9 statement by Michael Shaoul, chief executive officer with Marketfield Asset Management commented that the question now is if the problems with oil will remain local or perhaps stretch further. The big test will be if the significant drop in oil actually spurs credit problems in one of the emerging markets or high-yield energy.

Since 2009, prices for crude oil have fallen to their lowest while the most oil in 31 years is being produced in the US and global growth is slowing down. Specific to junk bond, this has affected the value because energy companies were a significant part of that market earlier in 2014. Also noted is that since 2005, share of energy companies on the S&P 500 Index have had the smallest drop.

At the end of August, speculative grade notes of energy companies lost 14%, causing returns of debt with a similar rating to decline.

As for dollar denominated high-yield bonds, the average yield is 1.2% points greater than US equities yield earnings compared to average 0.2% less in the past three years for stocks.

The chance these markets are coming back to more of a normal relationship exists, with yields for speculative grade debt being significantly greater than equities. For three years going through 2008, yield for debt hit an average 3.7% points over equities.

Investors will now need to determine if energy companies will begin to default, which in response would create a ripple through incredibly resilient stock markets or if the recent selloff of bonds is nothing more than an overreaction that could present new opportunities to buy.

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