The one chart that everyone's talking about

If there is one chart out there that everyone is talking about (or should be), it's the one pictured below depicting the relative performance of high yield and crude oil.   Although the long-term relationship between the two has been very scanty indeed over the years, since the beginning of last year the relationship has been fairly tight and, presumably, causal, given the preponderance of energy firms in the high yield index.

However, as you can plainly see there has been a significant wedge driven between the two series as crude has been hit hard over the last month or two while high yield has rallied quite smartly.   The reason for this is very simple indeed: energy credit has remained exceptionally resilient, with the Bloomberg energy high yield index near its highs and up more than 22% YTD.

Now, Macro Man will leave it to the credit experts out there to go through each name in the index bond by bond and determined whether they have managed to refi/roll their exposures and slap on massive crude hedges at the ding dong highs.   Macro Man supposes that it's theoretically possible, but it seems rather unlikely.

What he does know, however, is that the calls from the cognoscenti that the crude market would be back in balance by the current quarter or at latest next quarter are looking rather wide of the mark.  Now much like in credit, your author does not pretend to any particular expertise.  What he can offer, however, is big picture observations from a reasonably intelligent outsider that sometimes get waved away by specialists, who tend to focus on minutiae.     And the simple fact is that crude inventories in the United States (where the best and only really reliable high frequency inventory data is published) have seen their earlier decline in the growth rate ebb and indeed reverse.

While it's true that the inventory growth rate is well below levels that pushed crude to its lows, it is also the case that the current build rate remains very high by historical standards; the y/y change in  commercial crude inventories is in its 90th percentile of the last two decades.   It would be one thing if that growth rate were coming off a low level on inventory, but in point of fact US commercial crude inventories are essentially at record highs.  Perhaps the US is an anomaly, but given tepid levels of growth elsewhere that seems rather unlikely...almost as unlikely as supply and demand being in balance when the market keeps throwing out excess barrels that add to inventories on a weekly basis.

As such, a small klaxon is ringing in Macro Man's office calling out "Achtung! Achtung!"  (OK, not really, but it's a lovely image, isn't it?)  It's true that despite the apparent overlay correlation above, the investment performance of crude and high yield has not exactly been joined at the hip, as a comparison of six month rolling information (i.e., return-to-risk) ratios illustrates.   Note that the crude ratio below does not account for monthly rolls, so is obviously overstated.

Still, we can lay out the following facts:

1) For eighteen months from the beginning of 2015, the price correlation between  crude oil and the high yield total return index was quite high

2) There is a plausible explanation for this correlation, viz. the high weight of energy firms in the high yield index

3) Crude oil has recently dropped 20%

4) This does not seem out of line with current market fundamentals

5) High yield energy bonds have yet to really budge in price or return

6) Ergo, neither has the index

7) This seems unrealistic if crude continues to decline

8) High yield enjoyed a 6m return-to-realized vol ratio of more than 4 as of two weeks ago

9) Thus, high yield (particularly energy high yield if you can isolate it?) looks like a sale, perhaps hedged with a small long delta in crude (OTM call spreads, maybe?)

10) File this one under another brick in the wall of worry