A Calm Reflection

361 Capital Market Commentary | March 9th, 2020

Is there no time better than during the wildest volatility in a decade to sit down and think about your portfolio? The markets have been tested hard the last three weeks; first by the Coronavirus, and now by an Oil Price War. Energy prices down by a third. Risk-free yields near zero. Equity market volatility through 50%. Stock market futures locking limit down. Credit spreads surging. And the US$ in a waterfall formation. The moves are extreme but reflect the now-dual uncertainty of something that we have not seen since the Great Financial Crisis of 2008. Don’t expect this volatility to end anytime soon. COVID-19 cases are far from peaking in the U.S. The Fed is getting more limited in its market assistance options, and Washington D.C. is failing to inspire confidence. A “V” shaped bounce to all-time news highs will not be happening for the equity and risk asset markets this time around.

But this also does not look like a 2008 GFC panic which led to a collapse in real estate valuations and an 80-90% decline in bank stock prices. Consumer and Bank balance sheets are relatively healthy this time around. Sure, the collapse in energy prices and the travel and leisure industries will feel stress, but this will be nothing like when many individuals lost their homes and jobs in 2008-2010. COVID-19 is a controllable pandemic as China and South Korea have shown. And while the U.S. is now a net exporter of energy products, falling oil and gasoline prices will be welcome relief to all U.S. consumers. Our economy and the markets will get past these two large roadblocks but it will take time. And, during that time the news will get better, and it will get worse.

Most all companies are going to be lowering their earnings estimates which is being reflected in the current falling stock prices. As prices fall, investors will weigh the new earnings and valuations and adjust their portfolios accordingly. Some companies will benefit in the near term from the falling energy prices, interest rates and a decrease in mobility. Other companies will get hurt and their stock certificates may become collector items. There will be many winners and losers to pick from, on both the long side and the short side.

If you thought that equity investors had a challenging road ahead of them, what about the road for fixed income investors? While U.S. Treasuries have been an incredible place to invest, where do they go from (now) sub 1% yields? And I am guessing that not many will want to stick their necks out on credit risk as the U.S. economy slows. The 40% in bonds of a 60/40 portfolio has been a solidly appreciating store of value during this three-week scalp in the equity markets, but what can bonds do from here? A store of value during these tough times is what I see. But at some point in the future when we pass the roadblocks, be careful because yields can reverse quite quickly.

For now, there have been few signs of large equity buying in the markets. We have seen more voluminous selling on the down days than buying on the up days. Companies and insiders are buying, but this has been minor as compared to the amount of selling. I would look for the credit markets to stabilize, combined with multiple days of stability following additional Fed and Government actions, before we can start hunting for a bottom. A topping in Italian and U.S. COVID-19 cases would also be helpful to market psychology, but this could be a ways off and depend on more dramatic containment measures. Speaking of which, has the NCAA put together a March Coronavirus Madness ticket package with games in Spokane, Sacramento, Los Angeles and New York City?

Be careful out there with your portfolios and your health. In a year we will look back at 2020 and analyze the heck out of all of these market moves. For now, we get to buckle up in the roller coaster.

The Dow updated for Monday’s wild ride…

Dow Roller-Coaster Ride

The biggest one-day decline in oil prices since the Gulf War…

While the world was focused on COVID-19 this weekend, the Saudis threw a wrench into Putin’s plans to take global market share.

Brent Oil 1D Percent Change

A once in a lifetime event for the crude oil markets?

“It is very rare for a demand collapse to coincide with a supply surge,” said Bob McNally at the Rapidan energy Group. “It is the most crude price-bearish combination since the early 1930s. The price collapse has just begun.”

Brent crude, the international benchmark, dropped from $45 a barrel to $31.02 a barrel in one of the biggest one-day drops in its history, with traders spooked by Saudi Arabia’s decision to launch an effective price war just days after trying to secure a deal with Opec and Russia to reduce production.


The ‘Oil Wars’ accelerate…

The rise of U.S. fracking has pushed OPEC and the Russians to fight over the non-U.S. energy demand markets. And this looks as competitive as the cola wars.

OPEC Needed to Respond

Goldman Sachs sees $30 per barrel as the new forecast…

We believe the OPEC and Russia oil price war unequivocally started this weekend when Saudi Arabia aggressively cut the relative price at which it sells its crude by the most in at least 20 years. This completely changes the outlook for the oil and gas markets, in our view, and brings back the playbook of the New Oil Order, with low cost producers increasing supply from their spare capacity to force higher cost producers to reduce output.

In fact, the prognosis for the oil market is even more dire than in November 2014, when such a price war last started, as it comes to a head with the significant collapse in oil demand due to the coronavirus. This is the equivalent of a 1Q09 demand shock amid a 2Q15 OPEC production surge for a likely 1Q16 price outcome. As a result, we are cutting our 2Q and 3Q20 Brent price forecasts to $30/bbl with possible dips in prices to operational stress levels and well-head cash costs near $20/bbl.

(Goldman Sachs)

Oil price collapse thoughts…

Tweet from @tracyalloway

Will production destruction set up a future inflation shock?

Hydrocarbon III: “First all the marginal E&Ps will go bankrupt, then the excess oil will be absorbed,” explained CO2. “2020 CAPEX budgets were already headed lower; this is the nail in the coffin. No more projects. No more exploration,” he said. “The seed for rampant energy inflation has just been planted. And it’ll take so long for the seed to sprout above ground that everyone will assume it failed to germinate and write it off. But it’ll grow underground for a long time, then surface, and when it does it will be more explosive than anything ever seen in energy.”

(Eric Peters)

When an oil price collapse is very, very good…

Tweet from @teasri

Lebanon had some really bad timing…

Lebanon said it would default on its dollar-denominated debt, intensifying the Middle Eastern state’s financial turmoil and setting up a possibly messy negotiation with foreign investors.

Beirut’s failure to honor its massive debt load was long expected and not related to the economic turmoil caused by the coronavirus outbreak. But it comes at a time when the global financial system is on edge.

Lebanon said Saturday it would fail to pay back U.S. dollar denominated bonds with a face value of $1.2 billion due Monday, the first time the country has ever failed to pay its debt. It has another $700 million due in April and $600 million in June.

“Lebanon is facing an economic crisis of unprecedented scale,” said Prime Minister Hassan Diab, who took the helm earlier this year. “How could we pay creditors while hospitals are subject to medical-supplies shortages?”


Credit spreads see stress…

Both high grade and high yield are blowing out. Stock markets will need to see relief here to get buyers to return.

High Grade Spreads
High Yield Spreads

Something we have never seen before…

The whole U.S. Treasury yield curve trading below 1%!

US Government Bond Curve

Thoughts from Gary…

While the markets are looking to the Federal Reserve to cut the Fed Funds rate toward zero, the former White House insider has other plans to help an economy hurt by COVID-19 containment.

Tweet from @Gary_D_Cohn

Nancy Lazar sees both Rate Cuts and Policy moves coming to help…

Tweet from @csm_research

The Morgan Stanley U.S. Equity Strategist getting more cautious…

“The Fed’s insurance cuts last year now look like the beginning of a full-blown easing cycle. The track record of emergency rate cuts is not encouraging, with 7 of the 8 in history either preceding a recession by a few months or accompanying one…until interest rates normalize, defined as real 10-year rates back toward zero, we think the market will demand a higher than normal ERP (i.e., above 450bps) and as high as 600bps+ in the event of a recession…We adjust our bear case earnings forecast lower today as risks are now greater from consumer responses to the virus and lower oil impacting solvency, business investment, energy employment, and financial conditions via credit markets.”

(Morgan Stanley)

The U.S. stock market is not a fan of emergency Fed rate cuts…

How does S&P perform after a surprise rate cut? Not too well. Note that some of these episodes overlap each other, so it’s a small sample size. That said, the mediocre performance stats hint that the eventual path of growth – the reason the Fed is cutting in the first place – ends up a more important driver of market performance than the Fed cut itself.
(Goldman Sachs)

Cumulative S&P 500 return
(Goldman Sachs)

Lower interest rates and falling gasoline prices are good news for consumers…

Lower Interest Rates and Gasoline Prices

My “I want to scare the hell out of you” COVID-19 datapoint…

Listen, if you are over 70 years old, just avoid all crowds, don’t shake any hands, stay away from kids and master your cooking skills at home. This will all be over at some point. You definitely do not want to get this virus.

In Washington State, the nursing home that has faced the brunt of the coronavirus outbreak thus far in the United States said on Sunday that it had seen some residents go from no symptoms to death in just a matter of a few hours.

Tim Killian, a spokesman for the nursing home, Life Care Center of Kirkland, said its medical staff had found the coronavirus to be troubling, volatile and unpredictable.

“It was surprising and shocking to us that we have seen that level of escalation from symptoms to death,” Mr. Killian said. He said the center was still in triage mode as it worked to get a handle on the issue for its remaining 55 residents.


So consistent sleep patterns will help fight off COVID-19?

More sleep science research just came out. We need to stick to a routine. I thought my fellow sleep science nerds would like this too.

A new study published Monday found changing your regular sleep-wake time by 90 minutes — in either direction — significantly increases your chance of having a heart attack or heart disease.

A regular sleep time was defined in the study as less than 30 minutes difference, on average, across seven nights.

“Compared with people who had the most regular sleep time, those with the most irregular sleep time — more than a 90 minute difference on average across seven nights — had more than a two-fold increased risk of cardiovascular disease over a 5-year period,” said study author Tianyi Huang, an assistant professor of medicine at Harvard Medical School.


With Purell in short supply, we found a more multipurpose item on the internet this weekend…

It will clean both the counter tops and your throat and mouth.

Crown Royal spray bottle
(The Internet)

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