This Exhibit illustrates trends in High Yield (HY) credit spreads for mining, energy and the broader US HY market since 1997. Rising spreads generally indicate growing risk typically resulting from lost pricing power and growing deflation. The Exhibit shows there are three peaks in credit spreads related to three asset bubbles including the 2001-2002 technology bubble, the 2007-2008 credit bubble related to the housing market, and the most recent 2014-2015 peak related to the commodity bubble. What's noteworthy is that it typically takes 2-3 years for peak spreads to retrace and normalize.
HY credit spreads related to mining have generally had the largest amplitude, followed by energy and then the broader US HY market. We highlight the following observations:
1. US HY spreads peaked at 11% in 2003, 22% in 2009, and are currently at 7%. We think US HY spreads have more room to widen.
2. HY Energy spreads peaked at 11% in 2002, 15% in 2009 and are currently at 16%. We think HY Energy spreads are peaking.
3. HY Mining spreads peaked at 17% in 2002, 18% in 2009 and are currently at 16%. We think HY Mining spreads are peaking.
Clearly, the mining and energy sectors are under significant pressure because commodity prices have collapsed. This means that these companies are facing commodity price deflation. Resource projects financed with debt will struggle to repay that debt since commodity price assumptions originally used to secure the debt is likely less than half of the original assumptions. Debt restructuring, combined with higher commodity prices will ultimately cause risk, and therefore credit spreads to ease. Commodity prices will eventually move higher resulting from a combination of capacity shutdowns, industry consolidation, and higher demand (China, India, Infrastructure stimulus spending?) as the global economy repairs itself. As highlighted, the cycle typically takes 2-3 years from peak spreads to trough.
Written by Michael Durose
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.