Oil was in a funk before Russo-Saudi price war Oil was in a funk before Russo-Saudi price war http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\oil-barrels-chart-small.jpg March 10 2020 March 9 2020

Oil was in a funk before Russo-Saudi price war

High yield has been underweight energy for some time on its roller-coaster past.
Published March 9 2020
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There’s no sugar-coating today’s plunge in oil prices and its impact on high yield bonds. With independent energy and oilfield services comprising more than 6% of the Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index, the index is going to take a hit on the race to a bottom in oil prices—West Texas Intermediate crude closed down 25% at $31.13 a barrel, a 4-year low and its worst day since 1991.

The good news, from a Federated Hermes perspective, is our high-yield model portfolios have been underweighting energy for years, particularly independent energy and oilfield service companies. We’ve seen too many up-and-down cycles in these areas to feel comfortable, particularly in a world where price moves come much more rapidly due to algorithmic and high-speed trading and in which fracking technologies keep adding to global supply. We prefer stable, predictable cash-flow stories—in good markets, you are not compensated for owning levered companies with volatile earnings streams (energy, mining, oilfield services are examples) and in volatile markets, there are downside risks in commodity companies as we are seeing today.

Moreover, in our recommended sector allocations for our fixed-income products, we moved from neutral to underweight high yield for the first time in a decade as the calendar turned to 2020. We felt the situation was about as good as it could get and didn’t want to be caught long if the market turned. That’s not to suggest in any way that we saw the one-two punch of the coronavirus and oil-price war coming, only that after such a strong run for corporate credit, things were bound to cool off. Outside of the riskier “high-yield tail,’’ consisting primarily of energy, commodity and pharmaceutical components of the high-yield benchmark where the gap between yields on those bonds and comparable maturity Treasuries is extremely wide, the so-called spread for the remainder of the high-yield universe had narrowed to 20-year lows on a median basis.

We continue to monitor data surrounding Covid-19 and oil prices, and to make adjustments accordingly. These developments have led to price volatility in the high-yield market, particularly in energy, lodging and leisure sectors. The concern, of course, is the slowing global economy and recession potential arising from virus-related supply-chain disruption and demand destruction. The oil-price war between Russia and OPEC simply adds to these worries, with tumbling commodity prices creating more headwinds not only for resource-rich emerging countries but for the U.S. as well.

Tags Fixed Income . Volatility . Markets/Economy .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bloomberg Barclays US Corporate High Yield 2% Issuer Capped Index: The 2% Issuer Cap component of the US Corporate High Yield Bond Index. Bloomberg Barclays US Corporate High Yield Bond Index is an unmanaged index which measures the USD-denominated, high yield, fixed-rate corporate bond market. The index follows the same rules as the uncapped version, but limits the exposure of each issuer to 2% of the total market value and redistributes any excess market value index wide on a pro rata basis. The index was created in 2002, with history backfilled to January 1, 1993. Indexes are unmanaged and investments cannot be made in an index.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Diversification and asset allocation do not assure a profit nor protect against loss.

High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risk and may be more volatile than investment-grade securities. For example, their prices are more volatile, economic downturns and financial setbacks may affect their prices more negatively, and their trading market may be more limited.

Federated Investment Management Company