Oil and High Yield Correlations Stay Strong

March 31, 2016

Oil and High Yield Correlations Stay Strong Photo

The rally in high yield credit and other risk markets since the market low in mid-February has been impressive.  Driven by dovish central bank actions, the rally in crude oil prices and a weakness in the dollar, most markets have more than recouped all the losses incurred during the first six weeks of the year.

One of the correlations that market participants have hoped would decouple over time has been between high yield bond spreads and the price of oil, which has been intact for over two years.  However, as seen in this week’s chart, the two markets continue to move in lockstep.  Because of the high correlation with oil prices, it is increasingly difficult to have a call on the attractiveness of the high yield market without a call on oil.

While the large decline in the market value of energy bonds reduced their relative weighting in the J.P. Morgan High Yield Index in 2015, the rash of investment grade downgrades over the last few months has caused the energy component to actually rise.  Thus, the direction of the Index remains heavily tied to sentiment and prices in the energy space.  This has been particularly evident this year, as the market’s total return performance has tracked the 25-30% oil price move from $40 to $30 and back to $40.

Key Takeaway: I periodically use high yield ETFs to express tactical views and capture market beta in a vehicle that is more liquid than cash bonds.  However, since the overall Index is still heavily weighted and tied to the energy market, an Index investment at this point implies a bullish view on oil.  Underneath the Index, the bulk of the non-CCC high yield cash market has decoupled from the energy and metals distress and opportunities periodically present themselves.  My search for credits with identifiable catalysts away from commodities continues.

Tags: Chart of the Week | Oil | High-Yield Bonds | Correlation | Exchange Traded Funds (ETFs)

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The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.

This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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