Junk-Bond Buyers Greet Crude Reality After Year of Euphoria

Updated on
  • Oil below $50 rekindles memory of commodity-led credit selloff
  • Borrowing costs on high-yield debt rose most in four months

Why the U.S. Is Swimming in Oil

It’s the familiar stink of oil that has junk-bond investors groaning again.

The longest slump in the price of crude since the U.S. presidential election has jolted markets -- splintering the calm that had delivered mammoth gains for debt investors over the last year. Now, some of them are heading for the exits as they look to pocket the gains and sidestep any concerns over a repeat of the commodities plunge that wreaked havoc on credit markets the last time around.

Bond savant Bill Gross made it harder for the faint of heart on Thursday, saying the “highly levered financial system is like a truckload of nitroglycerin on a bumpy road.” With borrowing costs on high-yield debt hovering around the lowest level since the 2008 crisis, money managers are buying protection against losses, while junk-bond funds posted the biggest redemptions since November.

“The $50 oil was a psychological level,” Gautam Khanna, a portfolio manager at Insight Investment, said in an interview. “Seeing it below that is perhaps spooking the market a little bit.”

Crude dropped 2 percent to trade below $49 per barrel at 12:54 p.m. in New York, extending the decline this week to almost 10 percent. That would be the biggest weekly decline since the five days before the election.

Energy-industry bonds make up one of the biggest groups in the $1.4 trillion junk-bond index. That has meant the fate of the gauge has been closely tied to the price swings in oil over the last couple of years.

Market Indigestion

Average borrowing costs on the debt rose by the most in four months, according to Bloomberg index data. The cost to insure against losses on junk bonds using the Markit CDX North American High Yield Index, a benchmark in the credit-default swaps market, is headed for the biggest weekly increase since the first week of May.

“What’s happening with oil has led to the market going through a bit of indigestion right now,” Jordan Lopez, a money manager at Payden & Rygel, said in an interview. “But we are definitely not seeing the panic that we saw.”

Panic or not, the largest junk-debt exchange-traded fund posted its biggest outflow this year in the past week as investors yanked more than $2 billion from BlackRock Inc.’s iShares iBoxx High Yield Corporate Bond ETF.

“ETFs are puking stuff out because of the redemptions,” Jon Stanley, a money manager at Newfleet Asset Management said. “It could be a temporary pullback, but a lot will depend on where energy goes.”

Worrying Indicators

There are also other worrying indicators besides energy.

Stanley said he didn’t see a lot of encouraging signs last week as he moved in and out of various presentations at the upscale Loews Miami Beach Hotel during the global high-yield and leveraged-finance conference hosted by JPMorgan Chase & Co.

The bevy of companies that presented status updates to investors were talking a lot about cost savings as a way to aid the bottom-line and not offering many clues on how they would accelerate revenue growth, according to Stanley.

“At this point of the cycle, long in the tooth, you would like to see some top-line growth,” he said.

That may have prompted some investors to revisit their high-yield bets as prices of the securities jumped.

The "high-yield bond market was richly valued, perhaps dangerously so," said Thomas Byrne, director of fixed-income at Wealth Strategies & Management. "I have been patiently waiting for the market to crack. I believe the process has started."

But the selloff is still modest compared with previous market downturns, according to Jimmy Levin, the head of credit at Och-Ziff Capital Management.

Some investors may be “eagerly awaiting market dislocations,” Levin said. “We are not convinced this is the beginning of a material correction.”

(Updates trading in fifth and seventh paragraphs.)
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