The relationship between equity prices and credit risk typically depends on the prevailing risk appetite regime. For asset prices, the ‘Risk On’ phase is one where high-risk assets are the strongest performers, and vice-versa for ‘Risk Off’. Exhibit 1 suggests that the Oil & Gas industry has moved strongly into the ‘Risk Off’ phase over the past year.
Exhibit 1 Average 6M Change in Share Prices for Oil and Gas companies by CBC*
Exhibit 1 shows that:
1) For the period February 2016 to August 2016, despite the oil price hitting major lows, the share prices of non-investment grade Oil & Gas significantly outperformed investment grade stocks. The average share price return on non-investment grade companies was +42% compared to +19% for investment grade entities.
2) Over the period August 2016 to February 2017, the two groups showed similar performance.
3) Between February 2017 and August 2017, non-investment grade companies have underperformed with an average share price return of -20%, compared with +3% for investment grade.
The oil price has been range-bound for the past year but generally weak. The hurricane season has had a significant, if temporary, impact on Gulf output, and OPEC have signalled continued efforts to maintain prices, but investors are clearly reluctant to bet on sustained higher prices for now.
*CBC = Credit Benchmark Consensus; a 21-category scale which is explicitly linked to probability of default estimates sourced from major banks. A CBC of bbb+ is broadly comparable with BBB+ from S&P and Fitch or Baa1 from Moody’s.
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