Energy junk starts looking better after burning up $42B

Wall Street analysts are starting to see value in an unlikely corner: junk debt of energy companies, which just had its worst monthly performance since the 2008 financial crisis.

But that’s also causing concern about the rest of the $1.3 trillion U.S. high-yield market.

While energy-related bonds have plunged 20 percent in the last year, riskier debt of companies in industries such as technology, restaurants, health care and banking have delivered positive returns.

The divide between energy and non-energy bonds is notable and somewhat worrying to analysts at UBS AG because it is unlikely to last. Either energy debt has to rally or the rest of the junk-debt market has to sell off to normalize the relationship between these two groups.

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It will probably be some combination of both in the view of Matthew Mish, a senior credit strategist at UBS in New York. Here’s the logic: the bonds outside the oil and gas industry are not as immune to the historic plunge in commodity prices as investors may think.

Either they’re more reliant on natural-resource prices than investors are accounting for, or the drop in oil prices signals that the global economy is cooling more than many have thought. That’s bad for companies hoping to increase their revenues enough to pay back big loads of debt.

“We haven’t really been big believers in companies benefiting from low oil prices,” Mish said. It’s unlikely that there’s absolutely no correlation between the fate of the energy sector and all the others.

Investors are largely disregarding this and seem to be viewing the energy industry as largely walled off from every other business. They’re demanding about the greatest amount of extra yield to own the oil and gas junk debt over the rest of the market in Bank of America Merrill Lynch index data going back to 2005.

Energy junk bonds have lost about $42 billion of market value in the past 12 months, and about $13 billion in August.

It’s a good bet that energy-related debt is poised to do better than other junk, but that could spell trouble for the rest of the market.

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