Monthly Archives: November 2014

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Should you sell stocks? Check junk bonds first

junk bondsJunk bonds provide an early warning sign for Wall Street.


One man’s junk bonds might be another man’s treasure.

Dramatic swings in the junk bond market often provide a valuable warning to investors. During times of turmoil, investors pile into ultra-safe U.S. government debt and rotate away from far riskier junk bonds.

That swing away from junk bonds often happens shortly before stock market downturns.

“High yield does provide useful sell signals to equity investors,” Barclays analysts concluded in a recent report.

Related: Is it time to sell stocks?

Barclays combed through the past dozen years of data. The warning signal they found is a 30% or greater increase in the spread between Treasuries and junk bonds before a dip.

History is a guide: Consider 2002. The “spread,” or gap between the yields of junk bonds and Treasuries, spiked in July that summer after WorldCom defaulted on its debt and US Airways signaled it was filing for bankruptcy.

Investors who sold stocks based on the turbulence in the high-yield debt market would have escaped a 14% nosedive in the S&P 500 over the next 10 days.

“Had equity investors heeded the warning being sent from high yield, significant losses may have been avoided,” Barclays wrote.

While the stock market bounced back from that 2002 episode pretty quickly, the same can’t be said about when the sell signal was triggered five years later.

Related: OPEC’s message to US shale: Drop dead

Junk bond spreads surged in June 2007 as two Bear Stearns hedge funds dropped a bomb on investors about massive losses in subprime mortgage assets.

Despite the alarm bells ringing in the credit markets, the S&P 500 set all-time highs as late as the fall of 2007. But then stocks began a long descent as it came to light that many more firms had similar subprime mortgage problems.

Many investors clearly wish they listened to that early warning from junk bonds.

Barclays said equity investors should “position defensively” the next time junk bonds start to go haywire. That doesn’t necessarily mean dumping stocks altogether. After all, the stock market eventually bounced back from each of the sell-offs Barclays examined.

Instead, lower volatility sectors like consumer staples and utilities could provide investors with cover during a potential storm. The analysis found that after the sell signal was triggered, these sectors outperformed higher-turbulence ones like materials and energy.

What is the signal now? Few people have been positioning defensively these days. Despite a tumble in the energy sector on Friday, the S&P 500 capped off a strong month of November during which it rallied 2.5%. Tech stocks did even better, driving the Nasdaq 3.5% higher.

So what are junk bonds saying about the stock market these days?

Just like the tumbling VIX volatility index, junk bonds are indicating “things have stabilized over the past few weeks,” said TD Ameritrade chief strategist JJ Kinahan.

“As we all know, that can change at any moment,” he said.

If it does, chances are junk bonds will offer some early clues.


OPEC’s message to US shale: Drop dead

shale oil producer


OPEC just fired a shot at the U.S. shale industry.

Despite tumbling prices — the lowest since 2010 — the cartel surprised the energy industry by deciding to keep pumping oil at current levels. One motivation is to squeeze higher-cost producers in North America, including the booming U.S. shale industry that has reshaped the global energy landscape.

It’s a move Tony Soprano would be proud of. OPEC is betting lower oil prices will force U.S. producers to throw up the white flag and cut back on production because they won’t be able to turn a profit.

“The gauntlet has been thrown down for Western Hemisphere producers like Brazil, Canada and the United States,” Bespoke Investment Group wrote in a note to clients on Friday.

Related: Nightmare for oil stocks

Dot-com bust all over again? The fear is that OPEC’s hard line could cause a pull back in the U.S. shale industry, sparking job losses and causing panic in the financial markets.

That’s what Russian oil tycoon Leonid Fedun is predicting, although Russia isn’t part of OPEC.

“The shale boom is on par with the dot-com boom. The strong players will remain, the weak ones will vanish,” he told Bloomberg News on Thursday.

The OPEC move has clearly spooked investors, who sent energy stocks like Halliburton (HAL), Helmerich & Payne (HP) and Schlumberger (SLB) plummeting on Friday. (U.S. markets were closed for Thanksgiving Day on Thursday).

oil price drop

“I think there will be increased scrutiny of the balance sheets of the exploration and production companies. You’ll see some of the weaker players fall out,” said Tamar Essner, energy analyst at Nasdaq Advisory Services.

Related: The real Black Friday deal: cheap gas

Credit stress ahead: That scrutiny forced SeaDrill Limited (SDRL) to suspend its dividend earlier this week, causing the offshore drilling contractor’s stock to plummet 23%.

Essner “absolutely” expects more drillers and oil servicing companies to cut or even suspend dividends. Bespoke’s baseline scenario calls for dividend suspensions and bond defaults among more “marginal” named producers.

Many troubled shale companies will be able to avoid bankruptcy by selling acreage to boost cash flows though, said Per Magnus Nysveen, head of analysis at Rystad Energy.

No crash just yet: While financial stress could be looming for shale oil producers, experts aren’t forecasting a complete meltdown.

“I don’t think this will spell the death knell of the U.S. shale industry. Time and again this industry has proved very resilient,” Essner said.

Nysveen said the breakeven crude oil price for U.S. shale producers is around $ 50 or $ 55. Despite the recent plunge, oil is still well above that at the $ 70 range.

Those crucial breakeven points have been trending lower and lower in recent years thanks to technological advances that have made oil producers dramatically more efficient.

“U.S. production is much more competitive than 30 years ago,” Nysveen said.