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Will 2015’s be the Carnage of Treasury and Investment Grade Rated Bonds, Carnage Similar to the One That is Occurring Today in the Energy Sector?

Will 2015’s be the carnage of Treasury and investment grade rated bonds, carnage similar to the one that is occurring today in the energy sector?  Many, me included, have been decimated by the collapse of oil, a collapse that few had suggested even as recent as October 1.  Today the oil narrative is incredibly negative.

While the negative narrative is intense, according to Bloomberg energy insiders have been purchasing stock at its greatest pace since 2012.  Bloomberg further writes on a price to book basis energy stocks in the S & P 500 sell for almost a 40% discount to the entire index, the biggest since 2000.

Moreover, valuations of oilfield service companies are at levels that would only make sense in a deep recession.  As most know job and economic growth is accelerating in the US.

Debt of the energy producers has also been crushed with many issuances posting over a 20% decline in a month.


Several times I opined about sector rotation, comparing the buying and selling of a particular sector to that of locusts.  Perhaps I will change this description to a neutron bomb laying vast waste to a small area.

The narrative and selling will change when all least expect.  I for one hope that yesterday the energy sector capitulated.  As indicated above, the value is great.  Unfortunately a sector/company can remain oversold or overbought for a prolonged period where a month feels like a quarter and a quarter an eternity.

What does the above have to with the Treasury market.  As recent as October 1 oil was expected to average $105/barrel for 2015.  Today the average price is around $80.  Will the change in monetary policy and interest rates be the surprise for 2015?

I will argue a major reason for the decimation of the energy bond market is the result of trading and capital changes mandated by Dodd Frank.  There is no longer a backstop by the large money center banks for most debt issuances because of these changes making the market thin and illiquid, an environment exacerbated by selling pressure.  I think it is noteworthy that  Bloomberg writes where corporate bond holdings held in bank’s trading accounts are down around 75% form early 2013 levels.

What happens when the general corporate bond market breaks?  I will argue the ugliness we are witnessing today in the energy bond market will be nothing as compared to when bids evaporate for a $50 million ABC note offering of XYZ company.

Commenting upon yesterday’s market activity, the markets closed around 1% lower led by energy shares.  Treasuries advanced nominally on weak data from our trading partners.

What will happen today?  Will the inventory data impact sentiment levels?

Last night the foreign markets were down.  London was down 1.60%, Paris down 1.77% and Frankfurt down 1.40%.  Japan was down 0.68% and Hang Sang down 2.34%.

The Dow should open considerably lower on monetary policy concerns.  As written many times when the Fed changes monetary stance, the markets historically fall between 10% and 12% but are on average during the seven tightening periods since 1970 the S & P 500 is approximately 11% higher 20 months after the first tightening.  The 10-year is up 7/32 to yield 2.23%.  Oil is also up about $0.50/barrel.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.