Energy Stocks and Bonds Follow Oil Lower

Energy Stocks and Bonds Follow Oil Lower

 

The recent slide in oil prices has prompted investors to scale back on shares and bonds of energy companies at the time when markets broadly remain strong—a divergence some traders and analysts don’t think will last.
The oil market can send investors important signals about expectations for future global growth. The commodity is used throughout the economy, affecting prices on a range of goods and services from the cost of transporting goods to the price of plastics.

Divergence
Energy stocks have weakened while the broader market has held its gains.
Source: FactSet

The almost 20% decline in U.S. crude futures from their April high has caused some investors to grow worried that ongoing U.S.-China trade tensions could disrupt the global economic expansion. Oil prices have remained low despite efforts by the Organization of the Petroleum Exporting Countries to curb production and sanctions against Venezuela and Iran that have substantially reduced output from the two countries.
U.S. oil futures had failed to sustain gains after two tankers were attacked in a key route for crude transport. Prices settled Tuesday at $53.90 a barrel, down from their peak in April of $66.30.
Meanwhile, the broader U.S. stock market has been trading on a much more upbeat tone. The S&P 500 is up 16% for the year and has rebounded 6% this month. That compares with the S&P 500 Energy index’s 7.9% gain for 2019 and 5.9% advance in June.

Stocks and bonds whose fortunes are tied to the price of oil “are going to trade more on demand estimates than on supply shocks,” said Rebecca Babin, a senior equity trader at CIBC Private Wealth Management. That means either energy-related stocks should rise, reflecting improving prospects for growth, “or the rest of the market has to come lower” as the global economy decelerates further, she said.
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There are risks to company shares if the oil price falls much further, because many companies and analysts based their models for company profitability on a floor price of about $46 a barrel, according to Ms. Babin.
While stocks and bonds of oil companies have been hit by falling crude prices, the declines are much less pronounced than in 2015 and 2016 when oil tumbled to about $25 a barrel from more than $100 in previous years. The more muted losses this time around reflect the winnowing of weaker companies, according to investors.
Investor appetite for energy bonds has also lagged behind demand for company debt in general. Since oil prices peaked in late April, the extra yield, or spread, investors demand to hold U.S. high-yield energy bonds over U.S. Treasury’s has increased more than for regular high-yield debt, a sign of rising risk-aversion among investors.
About two-thirds of demand growth world-wide has come from emerging markets such as China and India, making prices very sensitive to the outlook for the global economy, said Gary Stromberg, head of high-yield energy research at PGIM Fixed Income.

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