Oil stabilizes: A boon for GCC assets
The delayed publication of data about positions in oil futures means that we cannot be certain but suspect last week speculative shorts were reigned in
Last week we flagged the talk of discussions between some of the major oil producers about production cuts which began to get more coverage in recent days. This chatter, more than the snow in north east of the U.S., seemed to help the oil market find a bid. The delayed publication of data about positions in oil futures means that we cannot be certain but suspect last week speculative shorts were reigned in.
However, net short positions almost certainly still remain large from an historical perspective. In relation to our opening comments, the level of the oil price with the nature of the recent rally and change in market tone makes us feel somewhat confident. Indeed January may have marked the low point for this cycle we feel. Inventory levels and supply remain high that will negate a stronger bounce but a new narrower range is likely to form leading to more stability in prices going forward. With this point in mind we are becoming more confident with shorter dated bonds from GCC issuers.
These bonds not only offer some good value currently, but remain a better play for more defensive investors. Incidentally, similar comments could be made about a number of commodities and basic materials, and it is important to note that China is apparently reducing oversupply in some of these areas. We continue to watch prices in this arena with interest.
High Yield bonds offering attractive valuations
For GCC issues and emerging markets, as well as those in the High Yield market, it is easy to get wrapped up in the narrative of the day. A narrative that has been relentlessly negative so far this year. But there are other perspectives. One is to view these securities relative to US Treasuries and other high grade bonds.
The spread differential or extra yield offered over these high grade bonds is approaching its highest levels since the Global financial crisis of 2009. Slowing US and global growth alongside a benign inflation environment has led to US Treasury yields approaching its recent lows. The accommodative actions taken by G3 nations of late with this backdrop could prove to be the catalyst to a rally in such risk assets that offer these high yields which does include equities also into the mix.
Whilst we are not back to the yield levels or spreads of 2008-2009, we are at the levels of October 2011 and in some cases have exceeded them. As per the BAML US High Yield index, yields are 9.2% at the moment, up from just over 5% in 2014 and compared with just over 10% in 2011.
Not surprisingly given the trials and tribulations of the energy sector (read shale oil and gas), the CCC rated or below part of the high yield index (the riskiest end of high yield) has shot through the 16% yield levels of 2011 and is just over 19%; this end of the market has been very difficult to navigate. Closer to home, the main EM external debt index from JP Morgan had a yield of 6.5% at the close of business on Friday. This is higher than the 6.35% that we saw in 2011. The JP Morgan MECI (Middle East Composite Index) has a yield of 5.08%, almost the same as in 2011.
If as we suspect the markets are going to pause for breath here we need to take stock of the significant changes in valuations seen in the last 3 months. While analyzing incoming data, we are looking at situations that are country specific and if global growth forecasts need to be revised down further. It may be worth picking through some of these higher yielding bond markets. Apart from the lower rated end of the US High Yield market (B- and below), the bond markets that have sold off the most in recent months have been Latin America and Africa. These bond markets are likely to be the outperformers in any corrective rally.