Not too hot, not too cold. That’s been the state of the domestic economy for the better part of seven years. Moderate growth, low inflation, low interest rates and access to capital markets have been key ingredients to generating solid returns in the corporate and structured bond market for the bulk of the post-crisis period. The Federal Reserve (Fed) has been the primary engineer, dampening volatility and pushing investors out of cash and into income-generating assets. Every time we think the party is about to end, the central banks have managed to maintain order and reestablish equilibrium. Unintended consequences notwithstanding, the feat has been impressive, to say the least.
As I help craft our investment strategy, I continually ponder numerous catalysts and tail risks that would disrupt the delicate balance that exists. I wouldn’t have guessed that the one that looked like it was about to tip the balance to the downside was the cratering of energy prices. Oil prices hovered near $80 to $100 for the better part of four years before dropping 70% between the summer of 2014 and the beginning of 2016. Like many, I thought the decline in oil prices would be contained and be an overall net positive to global gross domestic product (GDP).
At the end of January, it was obvious that was not a good assumption. The market does not like disorder, but neither does the Fed. In a remarkable turnaround, dovish Fed comments, which led to a weakening of the dollar and rapid rebound in equity prices, coincided with the market discounting peak oil production and energy default rates. The timing was uncanny. Oil prices started to lift off and, like every market before it, seem to have discovered their version of Goldilocks – or in dollar terms, $50.
Key Takeaway:$50 dollar oil now seems to be the new normal: The price which keeps debt and equity capital flowing, domestic oil production in check, OPEC at bay, and U.S. consumers happy. This would have been unthinkable a few years ago, much like 5% unemployment and sub 2% 10-year treasury rates. $50 oil will not produce great returns on capital nor will it prevent elevated defaults of highly levered and marginal energy companies. However, for the health of the broader bond market, it feels just right.
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.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.
High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
All trademarks are the property of their respective owners. This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission.
