“All that exists is just and unjust and equally deserving of both.”
—Aeschylus
Markets occasionally give you something outside of your experience, astonishing and terrible things that make you poorer but wiser. This is intrinsic to high yield credit: Correlation takes its iron grip and drags down the just and the unjust equally.
We got an example of this in the last few days. A real dead man walking, First Oil Corp widened 432 basis points yesterday. 432 basis points. The spread is now 3435 bps. Williams Co., a solid name widened 38 basis points on the week, spread now at 179 bps. A-rated energy companies are now priced worse than junk. If there was ever an indication of a meme being overdone, this is it.
Here’s the set-up: investment grade CDS spreads, ISDA Select 10 energy companies’ CDS spreads (SPCDQR50), and HY CDS spreads. Beginning in September, you saw energy sell-off. This week, we reached the point in the sell-off that investment grade energy names have caught down to high yield.
Today went full-on absurd (which only means it caught me off-guard) as they now trade cheap to high yield. See for yourself.
Based on oil's relationship to USD, oil prices will bottom in the low $50s. This relationship between USD and oil is the key to the trend, so and stable USD at these levels prices oil at $50/barrel and will burn through production hedges. Credit depends on solid balance sheets, and when oil is mkaing daily moves, this is difficult to know even for the C-suite. The fear is that global oil stockpiles, if liquidated, are enough to overwhelm demand for months ad in the process bust oil below the low $50s. This will be lethal.
Regarding the credit moves, leverage is a harsh but necessary master. Leverage forces you to sell when the price action gets rough, and so you are seeing huge sell-offs. If you are a poor soul that tries to hold on through this sell-off, you are now in a position where you just have to ride this out as best you can. This is a dreadful spot to be in.
The desperate belief that things will go back to the way they were is no way to live in the present, or to participate in tomorrow’s world. The truth is that everything is constantly changing and there is always something new under the sun.
That is to say the energy space for 2015 will be a hostile alien landscape for credit.