The oil price dropped to a new lower range last week, falling below $40 for the first time since 2008. Stocks and bond yields also fell in the same week as investors re-assessed their risk appetite, and The Dow Jones Industrial Average dropped 3.26% to close the week at 17,265.
According to Blackrock’s global chief investment strategist Russ Koesterich, the recent collapse in oil prices raises questions over asset classes ranging from high yield bonds to emerging markets.
He said the drop in crude has reinforced fears over slow economic growth and deflation, placing pressure on a range of asset classes related to energy.
Michael Stanes, investment director at Heartwood Investment Management, while maintaining an underweight position in the sector believes the market is becoming overly pessimistic about the fundamentals of individual names.
“The UK equity market is one of the most exposed to the commodities sector. At the height of the commodity super cycle, energy and mining stocks comprised more than 30% of the UK stock market. Alongside the decline of commodity prices since 2014, this weighting has now almost halved,” he explained.
High yield turmoil
Koesterich also points to how the collapse in oil prices has revived concerns over energy issuers in the high yield market. “Last week, the spread between the yield of high yield bonds and that of comparable Treasuries continued to widen as high yield sold off. Meanwhile, volatility rose and investor flows into the asset class once again turned negative,” he said.
Koesterich points to how valuations are now the cheapest in decades. “As such, for investors underweight in the sector, it may make sense to add to positions, particularly in those exploration and production names levered to low-cost shale deposits, such as those within the Permian Basin in West Texas, as well as some of the midstream MLPs,” he said.
Given recent developments, Stanes deems commodities to be an area of value going into 2016. “Another commodity super cycle is highly unlikely – China’s meteoric rise is one of those historical aberrations – but the commodities market should move into more equilibrium as producers adjust to supply-side structural shifts.”