Skip to main content

Chesapeake Energy (CHK) - Get Chesapeake Energy Corporation Report has fallen 93% since the middle of 2014 and is part of a group of distressed and "Stressed Out" stocks that TheStreet will be monitoring through these choppy markets.

Although shares of Cheseapeake Energy may not present a great opportunity right now for short-selling, their condition certainly reveals a lot about the state of financial markets. 

The financial crisis and subsequent race to zero interest rates by global central banks severely damaged financial markets. At first, this didn't seem so as bonds, commodities and stock prices all accelerated higher. In recent years, however, the idea of normalizing policy came back into focus.

The issue with normalization, though, was that asset valuations had already skyrocketed to a point that only made sense in a negative real interest rate environment. Any talk of hiking rates meant the environment ceased to exist.

Amid the monetary easing environment in the years following the financial crisis, many companies, such as Chesapeake Energy, increased issuance of debt at historically low rates. The low rates, as well as high energy prices meant that Chesapeake and other heavily indebted producers could pay off the debt loads with relative ease.

Image placeholder title

Chart provided by

When the Federal Reserve began discussing tightening interest rates, however, the markets quickly reacted. The dollar spiked higher in 2014, beginning a new and long-awaited uptrend. Commodities, priced in the U.S. currency, also began a steep decline from their lofty levels.

Commodity producers that had issued debt at cheap rates started to see their profit margins contract. The declining health of higher-risk borrowers sparked a selloff in junk bonds, pushing the yield spread significantly higher. Moreover, the prices of their stocks fell, leading leverage indicators to explode higher.

TheStreet Recommends

Below is a chart that plots the iShares Barclays 7-10 Year Treasury (IEF) - Get iShares 7-10 Year Treasury Bond ETF Report  against the SPDR Barclays High Yield Bond (JNK) - Get SPDR Bloomberg Barclays High Yield Bond ETF Report . This is a proxy for the spread between the yields on high-yield debt and Treasury securities. When the value on this chart rises, it signals that the yield spread is expanding, and that higher-risk borrowers are becoming more distressed. As of this week, the junk bond yield spread is approaching levels not seen since the Greek crisis in 2011.

Image placeholder title

Chart provided by

The selloff in commodities and junk bonds is now leading to a market-wide correction. The repricing of assets in a tightening monetary environment was inevitable, and now the market is searching for an appropriate valuation.

The market volatility has been so pronounced that investors have lowered expectations for further Fed rate hikes in 2016. This was never the Fed's intention, but it may now be the reality. In a flight to safety, investors have poured funds into the yen and out of the dollar. Consider that Japan recently cut its key lending rate to negative, while the Fed raised rates in December, making the recent move even more telling about the current state of global markets.

Below is a chart of the yen's value against the dollar. (Retail investors can easily make a bet on the value of the Japanese currency by purchasing CurrencyShares Japanese Yen ETF (FXY) - Get Invesco Currencyshares Japanese Yen Trust Report .) The yen is putting in a strong reversal pattern, and with its breakout above 86 vs. the dollar on Monday, the new trend appears to be confirmed. If more selling of stocks is to come, which is the most likely case, buying gold, gold-mining stocks, and the yen could yield the greatest results in 2016.

Image placeholder title

Chart provided by

For more articles on distressed stocks to avoid, read Real Money's "Stressed Out" stocks coverage. You can find more information on the index here.

This article is commentary by an independent contributor. At the time of publication, the author held shares of FXY.