For much of 2015 and earlier this year, the high yield fixed income market and oil prices were joined at the hip. If you wanted to know what high yield was doing, one of the best real-time barometers of the sector’s performance was crude oil prices. Since the start of the second half of the year, though, there has been a distinct shift in the performance of the two asset classes. The first chart below compares high yield spreads (left axis) per the Merrill Lynch High Yield Master Index to the price of crude oil on an inverted basis (right axis). From the start of the year through the end of June, the two moved tick for tick with each other, so that when crude oil prices rose, spreads narrowed and vice versa. Since oil made a short term peak and fell 20%, however, high yield hung in there as spreads remained right near their YTD lows.
Even within the energy sector of the high-yield market, spreads have become increasingly uncorrelated to oil prices. The chart below is the same as above except that rather than looking at the entire high yield market, we only show spreads in the high yield energy sector. Here we see nearly the same trend as the overall high yield market. Oil prices have declined (rising black line in chart), but spreads have remained relatively contained. One potential explanation for the lack of any major widening in spreads despite the decline in crude oil prices is that due to a slew of ratings downgrades, the overall credit profile of the “junk” sector is much better now than it was earlier this year as previously investment grade companies have now moved down to the ‘junk’ part of the sector. Whatever the reason, the high-yield market remains much less concerned about declining oil prices now than it did earlier this year.
On the subject of high yield, the fact that spreads have held up in the last several weeks has helped to maintain what is turning out to be a very good year for the high yield market. The chart below shows the performance of the overall high-yield market and energy in particular. YTD, high yield credit is up 12.7% after being down as much as 5% in February. High Yield Energy, however, has been the big star. After being down 19% on the year in February, the sector has erased the loss and turned it into a gain of 24.3%. And you thought equities saw a big turnaround in 2016!