Getting more comfortable filling up your SUV lately? Although those extra dollars give you more spending power away from the pump, the benefits of cheaper gas may cause unexpected ripples for the economy, oil stocks, and even the corporate bond market.
U.S. crude oil prices collapsed to a fresh six-year low this week as the world remains awash in oil. The latest inventory data revealed that stockpiles of U.S. crude oil jumped 4.5 million barrels to a record 448.9 million barrels through March 6, according to the U.S. Energy Information Administration.
In recent months, as stockpiles have been going up, crude oil prices have been going down. On the New York Mercantile Exchange, April crude oil futures tumbled from over $100 per barrel last summer to as low as $43.25 on Monday.
Conventional wisdom says lower oil prices are good for the economy, a de facto “tax cut” that keeps spending money in consumers’ wallets. But this time, investors need to dig deeper. "Conventional wisdom is wrong. It’s putting more money in people's pockets, but they aren't spending it, they’re saving it," says Eric Utley, Content Manager at Investools®.
Also, lower crude oil prices could dent hiring in certain industries. "The energy sector has been a leader in job creation, and we are already starting to see layoffs in that sector. Now if oil prices fall, that job creation goes away. From a broader perspective, lower oil prices are horrible for the economy," Utley says.
Higher Risk for High Yield
Cheaper oil could inject trouble into the high-yield bond market, too.
"In 2014, 18% of companies that issued junk bonds were in oil services," says JJ Kinahan, Chief Strategist at TD Ameritrade. For corporate bond market investors, lower crude oil prices are flashing a yellow warning signal. If crude oil prices stay low longer, there could be a spillover impact on the entire high-yield bond market, perhaps leading to defaults on interest payments. It also means that investors are demanding higher yields to take on the added risk.
"It has been estimated that most of those companies who issued junk bonds need oil to stay over $62 per barrel to be able to continue payments on their bonds. They can survive for six to nine months with oil under $62 per barrel, but once you hit the nine-month mark, it could affect payments," Kinahan says.
If there are big defaults in junk bonds, there could be a ripple impact on the entire fixed income market. "Rates will go higher on any non-government-issued credit, and people may roll out of junk bonds. It could hurt financing significantly. Any business that needs to borrow money could have trouble,” says Kinahan.
Opportunity Comes with Volatility
Oil services stocks could also see higher levels of volatility, which may provide opportunity in writing covered calls. Investors can assess the higher levels of risk and choose to avoid that sector or widen expected ranges if trading companies in that sector, Kinahan suggests.
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