Weekend Edition - Oil's Rout: 6 Prisms to Peer Through - Part 2

Weekend Edition – Oil’s Rout: 6 Prisms to Peer Through – Part 2

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In last week’s Sunday edition of the Premium Dividend.com Daily Newsletter, we discussed three ways to look at the rout, or precipitous decline, in oil prices over the last six months. The full piece is here, but to recap, we looked at it from these three angles:

  1. Dividend Investor Perspective: Specifically, we looked at some of the not-so-obvious dividend payers, like the Canadian banks, that may be affected by oil’s decline.
  2. Trader Perspective: We discussed how the USO’s recent spike in volume implies a lot of traders are taking long positions in crude and trying to catch a bounce. For more on how those so inclined could approach trading crude oil, see How To Trade Crude Oil Futures.
  3. Technology Media Company: We looked at how big a story the drop in oil has become. We also touched on how often people correlate oil’s movement to larger market movements, when in actuality, there’s likely little causation, despite a snappy sounding headline.

Today, we’ll look at three additional perspectives, those of a municipal bond investor, a mutual fund investor and a commodity ETF investor. Let’s dive in.

To recap, early in the week, oil continued its downdraft, only to bounce back later in the week. When the dust settled, WTI closed at $57.13 on Friday, slightly below last Friday’s close of $57.81.

Municipal Bond Investor Perspective:

A sister property of Dividend.com is MunicipalBonds.com, which is squarely focused on being the premier source for objective information related to the muni bond market for sophisticated individuals and financial advisors. While somewhat esoteric and unsexy, the muni bond market is huge, housing more than $4 trillion in aggregate value. While that’s approximately only one-quarter the size of the total capitalization of the U.S. stock market, it’s still a big asset class.

Given the specialization of the market, I reached out to an expert in the field, a friend of ours at Mitre Media, Steve Livlanich at Morgan Stanley. Steve’s based in Houston and specializes in nothing but the muni market.

I asked Steve: “How does the drop in oil affect the municipal bond market?”

Steve notes:

Quite simply, the drop in oil confirms slower GDP growth in the eurozone and throughout Asia. The current myopic growth rate outside the U.S. has created a strong flight to higher yielding safe havens, which at this point is U.S. Treasuries and municipal bonds.

To put things in perspective, the 10 yr. German Bund is yielding a .59% (editor note: down from .62 when Steve was asked) vs. the UST 10yr. at 2.16% (editor note:  2.08% at the time Steve was asked). With GDP slowing growing across the world and global yields at rock bottom levels, this will keep driving more capital to the U.S.

This could fuel the rally in US Treasuries and municipals to continue into 2015, with lower oil prices. The current deflationary environment will continue to put additional downward pressure on yields throughout the entire curve.

A great perspective on how a ~45% drop in the price of oil affects when, and at what price, muni bond issuers (for example, Alabama Drinking Water Finance Authority Revolving Fund) raise debt, hey?

Mutual Fund Investor:

The goal at MutualFunds.com is to be the #1 source in delivering precise mutual fund data for the over 26,000 funds that are currently bought and sold by retail and institutional investors. While the site is young and evolving, it’s making great strides, including the newly released and highly detailed fund pages. Looking at the rout in oil through the perspective of a “mutual fund investor” is a broad prism to look through, given the vastness of the instrument and how mutual funds can literally help investors gain exposure to nearly every nook and cranny of the broader markets. That said, let’s focus the discussion.

Recently, the team at MutualFunds.com noted that the drop in oil prices, and importantly the longevity of the decline, could impact the longer-term performance of a stock market darling of late, Tesla (TSLA).

Moreover, they dug into the universe of approximately 26,000 mutual funds and filtered out three funds with the largest stakes in the electric car manufacturer. The famous Fidelity Contrafund, Vanguard’s Total Stock Market Index and T.Rowe Price’s Price Growth Stock funds came up as the biggest holders of TSLA. While none of the funds own more than 2% of Tesla, it illustrates how intertwined the markets remain and how the impact of oil’s drop cascades throughout every corner of the markets. For the full article on MutualFunds.com, see here.

Commodity ETF Investor:

Given the unavoidable discussion about the drop in oil and how it reverberates through the market, it is good to understand what instruments can help investors gain exposure, either bullish or bearish, to the price of oil. In your search you may come across the burgeoning ETF (exchange traded fund) world. While we’re not apt to trade in this letter, we do think that understanding one of many keys to commodity ETFs is important for all investors.

  • ETF vs. ETN – Structure Matters!

    Oh boy, acronym overload right? Understanding a key difference between these two structures will resonate when it can potentially hit your pocket book. While the details are complex, quite simply, it’s good to understand that some commodity ETFs can be structured in a way where even without investor liquidity a cash tax liability can be triggered, if the ETF does well. This creates a cash liability and a paper gain, not a great position for anyone to be in without going in eyes wide open. Alternatively ETNs (exchange traded notes) do not have this feature; taxes are not due until the position is closed out.

    Bottom line: before jumping into a long (or short) position in a commodity ETF based on a bullish or bearish inkling towards the future price of oil, do your homework on the underlying instrument you’re gaining this exposure through, especially if it’s an exchange traded product. Luckily, we have excellent resources on ETFdb.com to do so; for example, check out this report on Commodity ETFs.

The Bottom Line:

In last week’s letter I noted, “If nothing else, the interconnected nature of the world’s financial systems was illuminated through the financial crisis.” While oil’s drop creates both crisis and opportunity, the main point is that no matter what area of the market you’re in or what instrument you’re investing in, you’re affected by the massive drop in oil over the past six months.

On a go-forward basis we look forward to helping guide our dividend-paying-equity investors through the markets, with the understanding that we’re focused on a sub-component of a much larger ecosystem.

Have a great weekend and talk to you on Monday.