Read This, Spike That
What Are Negative Junk Bond Returns Telling Us?
Is weak performance in the high-yield market foreshadowing a downturn in stocks?
By John Kimelman
Not so for their cousins, high-yield—or junk—bonds, which have lost several percentage points even after their interest payments are factored in.
“U.S. corporate high-yield bonds are down 2% this year, including interest payments, according to Barclays PLC data,” wrote The Wall Street Journal this past weekend, adding that junk bonds have posted only four annual losses on a total-return basis since 1995.
The Journal points out that the declines are worrying Wall Street because junk-market declines have a reputation for foreshadowing economic downturns.
If junk bonds lose value this year, it will be the asset class’s first down year since 2008. During the summer of that fateful year, junk bond prices fell sharply, just ahead of the big drop in the stock market following the collapse of Lehman Brothers in early September. Heeding that warning from junk might have saved stock investors a big percentage of that year’s losses.
According to the Journal, some of the junk bond selling has spread beyond energy firms hit by weak commodity pricing.
But here’s the good news for risk assets: Comparisons between now and 2008 are limited at best.
That year, the junk bond market lost a quarter of its value, while now it’s down just a few percentage points year-to-date. And the U.S. economy this year, despite the drag from the energy sector, is generating more than 200,000 jobs a month and running near the standard definition of full employment.
Speaking of the energy sector, there are a few articles that suggest that trouble remains both for energy stocks and, more particularly, the midstream pipeline sector, which has fallen hard this year.
A piece in the Financial Post, a Canadian business publication, discusses the five reasons it’s still too early to buy commodity stocks. All of these reasons apply to the energy sector and collectively comprise a strong headwind against this asset class.
Among those reasons are a likely rise in an already strong dollar, oversupply of commodities, weak inflation, and expected “tax-loss selling,” in which poor performing stocks including energy names are sold before the new year to offset any capital gains.
Perhaps the biggest surprise this year is the extent to which high-yielding energy pipeline stocks, many of which are structured as master limited partnerships, have fallen. This drop in the sector has come despite a widely-held belief that these so-called midstream companies were impervious to upstream pricing concerns because they were simple “toll collectors” in the energy transportation infrastructure.
The best-known of these pipeline stocks, Kinder Morgan (ticker: KM ), has fallen to $16.42 a share, 63% from its all-time high reached in April.
The stock lost 29% last week alone following reports the company would have to cut its dividend.
In a story over the weekend in Barron’s, associate editor Andrew Bary wrote that at their beaten-down price “downside in the stock, now $17, seems limited.”
But he adds that “the shares, however, don’t look like a bargain trading for about 17 times estimated 2015 earnings (based on generally accepted accounting principles), adjusted for a tax benefit, and for about 11 times projected 2015 Ebitda (earnings before interest, taxes, depreciation, and amortization). These aren’t low multiples for a leveraged, capital-intensive business that is showing no growth in underlying cash flow.”
Writing Monday for Bloomberg, columnist Liam Denning argues that if the company ends up flattening, or cutting, the dividend, it will be the clearest signal yet that the industry must heed the message coming from the public markets.
Denning concludes: “Kinder Morgan’s current dividend yield of 13% and the Alerian MLP Index’s yield of almost 10% roughly translates as: We don’t believe you can afford this.”
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