Interest Rates, Debt Service, and Energy
On October 27, the S&P 500 hit a five-month low. On that same day, the ICE 30-year fixed-rate jumbo mortgage (over $726,200 loan value) climbed to 8.278%. The same week, the 10-year Treasury rate climbed above 5% for the first time in 16 years. Clearly, this was not a coincidence – higher rates meant lower stock prices. Since then, rates have cooled due to lower inflation data and the market has bounced off of that low quickly. Rates are driving the stock market too, not just the bond market!
We believe investors should be utilizing this opportunity to continue to take advantage of locking in higher rates for longer time periods on bonds in their portfolios. We continue to buy individual treasuries, CDs, and investment grade corporate bonds yielding between 5.25% and 6% maturing in one to seven years. That type of return is difficult to pass up for a retiree, particularly one who might require less return than that for their annual spending.
Jeffrey Gundlach, CEO of DoubleLine Capital and perhaps the best bond manager in the world the past decade or two, spoke on CNBC on November 1 and spoke of great caution with regard to higher interest rate payments for the government and corporate entities. He mentioned interest rates are headed lower, primarily because he believes a recession is in the cards for next year. He mentioned that higher interest rates for the U.S. government are going to lead to higher deficits. This year, the federal government deficit will reach nearly $1.7 trillion, over $600 billion of which is interest, adding to the total U.S. debt of $34 trillion. He believes this is unsustainable and will force the government to cut spending, raise taxes, or both.
For managing portfolios, one item really sticks out now that hasn’t been a huge issue for a long time – how much debt does a company have maturing over the next few years? For instance, according to Factset, one of the major automakers in the U.S. had approximately $94 billion in debt at the end of June. Nearly $80 billion of that debt is coming due over the next three years. Most of these debt maturities had coupon rates of 3.5 – 4%. Their most recent debt issuance was nearly 7%. If they have to refinance $80 billion of debt at 3% higher interest rates than they currently pay, that will equate to an extra $2.4 billion of interest each year. That is from a company that has only made between $1.6 - $7.6 billion in net income in the past five years. The impact on earnings of higher interest rates for companies is going to be substantial if they have to refinance that debt soon.
The Energy Information Administration said on Tuesday that per capita gasoline demand is expected to fall to a twenty-year low next year. They believe this is due to improvements in fuel efficiency and other sources, the work-from-home movement, and higher non-energy household expenses. Combine this with the expected slowdown in both China and the U.S. next year and the recent falloff in crude prices and energy stocks seems to make sense. However, the EIA also said they expect Brent crude to average $93 per barrel in 2024, which doesn’t make much sense versus their economic and demand expectations, which could only mean that they believe that oil supply will be able to be controlled in order to maintain higher prices. They specifically mention that the OPEC+ countries will most likely maintain production cuts enough to offset any other production growth across the globe. From a stock perspective, there seem to be haves and have-nots. Most energy stocks are down well over 10% in the past 12 months. Yet pipeline companies, which are traditionally more stable and provide better income, are mostly positive. The ETF that we have historically used in the pipeline space, AMLP, is up over 10% in the past year. For stability and income, we continue to prefer this ETF or individual pipeline or energy MLP companies to the producers for the time being.
As always, don't hesitate to contact us if you have any questions about your personal portfolio.
Nate Lovelle, CFA
Director – Portfolio Management, Council Oak Wealth Advisors
918-984-9102 (Direct)
918-779-4022 (Fax)
All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change.
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