Oil Prices, Junk Bonds, And Other Bubbles

Emerging signs of economic strain underscore the need for financial prudence.
Kevin Heal

The global marketplace has shown signs of strain in the past few days. Having been through my share of heady upheavals over the years, I wanted to share some insight that will help with financial decision-making in today’s market.

A Market 30 Years In The Making

When I started in this business almost 30 years ago, we tracked hours with punch cards and shared computers. Fax machines were the rage. Here’s what’s happened since:

1987 The stock market crashes and junk bonds blow up. Things start to improve until …

1990 The United States falls into a major recession. The Fed lowers interest rates to help the economy improve. The easing of rates continues until …

1994 A small-time money manager in Orange County nearly causes the entire state of California to go bankrupt and the contagion effect bleeds into other markets. Things start to improve in 1996 and are moving along swimmingly until …

1998 Russia experiences an economic crisis and begins devaluing the ruble. It also defaults on debt, which causes a number of emerging countries to almost go belly up. In The United States, a large hedge fund called Long-Term Capital nearly takes down a number of financial institutions. The Fed gets Wall Street to bail out the fund at a cost of $3.6 billion. Things start to improve until …

2000 The dot.com bubble hits. The NASDAQ peaks at a little over 5,000, and a ton of Internet stocks never again see the light of day. The mania ends and people go about their day jobs rather than their day-trading jobs. Again, things start to improve until …

2007-2010 The mortgage crisis hits, and its effects still linger.

Which brings us to today. What is happening that might affect our investments, both institutional and personal? What could ruin our holiday good cheer? Oil prices are down almost 50% from their summer peak. That’s a good thing, right?

Russian Rumbles

As it turns out, Russia and its notably surly leader, Vladimir Putin is dependent on oil revenue. In fact, 60% of its imports are just that. To combat the price plunge, Russia is devaluing its currency. Rubles are worth much less, so Russians are waiting in line to spend their rubles on basics like cheese and blue jeans with the expectation that there will be a further price drop in their national currency.

Other nations are taking note and worrying about how Putin will react politically and militarily to rally his flagging support. In regard to money matters, here’s a tidbit: Apple has suspended sales to Russia because the tech goliath can’t reliably price its products.

But We Got Our Own Problems

Approximately 15% of high-yield (junk) bond holdings in mutual funds are related to oil. Many bond issues that were priced at 100 cents on the dollar are now trading for half that.

Some notable Wall Street sharpies are putting billions of dollars in hedge funds betting against those bonds, according to Business Insider. Other investors are seeking their own kinds of shelter.

So the same thing that happened in the late 1980s is occurring again in the high-yield market. Meanwhile, the U.S. housing market is starting to allow the same types of mortgages such as 3% or no-money down that were the root cause of the most recent mortgage crisis.

Adding to the froth: Speculative IPOs such as Lending Club, symbol LC have been priced at more than $1 billion when management is not sure how they are going to make money. Perfect, see the 2000 dot-com bubble above.

In 28 years I have experienced six different financial crises. That’s one every 4.67 years on average. The last one was in 2010, so by that measure we’re coming close to something occurring. Any one of these examples might be the one. Or it could be something else. Or it could be a combination of things.

So what can you do? First, check out how much oil is in your portfolio. If you own an emerging market fund, check the holdings. A high-yield bond fund for sure is going to have some exposure. A small cap or mid cap equity fund might also have some exposure.

I’m not saying to sell, but I am advising you be aware of the risks and percentages.

Kevin Heal is vice president of Callahan Financial Services (www.TRUSTcu.com). He has more than 25 years of sales and trading experience with both large investment banks and regional broker-dealers.

December 18, 2014

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