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Oil Price Crash Was Inevitable
Oil Price Crash Was Inevitable
The oil price crash was inevitable.
To understand why we have to review a bit of history.
In 2013, I began warning of the risk to oil prices due to the ongoing imbalances between global supply and demand. Those warnings fell on deaf ears.
Nobody wanted to pay much attention to the fundamentals at a time when near-zero interest rates were pushing banks, hedge funds, and private equity firms, to chase the “yield” in the energy space. Naturally, with money flooding into the system, companies were forced to drill economically unproductive wells to meet investor demands, which drove supplies higher.
Disclaimer
This week’s #MacroView is a broader commentary on the more general issues of the oil market. However, given this backdrop of what oil prices will likely remain suppressed far longer than most currently imagine, some opportunities exist in the energy space.
We recently added positions in Exxon (XOM), Chevron (CVX), and the SPDR Energy ETF (XLE) to our portfolios. We believed the companies offered significant value before the crisis, and offer even more due to the sell-off in oil.
Based on our discounted cash flow model for XOM and CVX, we think both companies are 25% undervalued. The model assumes very conservative earnings projections for the next three years and a low EPS growth rate after that. In addition to trading at a steep discount, we think their strong balance sheets put these companies in a prime position to purchase sharply discounted energy assets in the months ahead.
These stocks, and the sector, will be volatile for a while, but we intend to add to these positions in the future and potentially hold them for a long time.
Now, for the rest of the story.
…click on the above link to read the rest of the article…
A Pandemic Iceberg Hits the ‘Unsinkable’ U.S. Economy– A Map Ahead
A Pandemic Iceberg Hits the ‘Unsinkable’ U.S. Economy– A Map Ahead
The ‘unsinkable’ Titanic was designed to withstand a breach of four compartments, ensuring the ship would stay afloat. On the evening of April 14, 1912, the ship hit an iceberg, breaching five compartments, and within two and half hours, the vessel sank. Many investors think the U.S. economy, like the Titanic, is unsinkable as well. Yet, we have discovered the economy can sink when the most vulnerable sector of our economy is hit – the consumer. The country has been severely damaged by a pandemic iceberg aimed right at the consumer. Never in the history of our country have we shut down 25% of economic output in a few weeks. In just three short weeks, millions of people are out of work or furloughed with millions more to come. Goldman Sachs expects an unemployment rate of 16% or higher, levels not seen since the Great Depression. The Michigan Survey of Consumer Sentiment dropped to 71.0 for April from March’s 89.1, the largest drop on record. Consumers are sheltering in place, not going to work, or buying at stores, causing spending to drop precipitously as concerns about job security soar.
How did consumers become so vulnerable to a loss of income, job security, and standard of living? It started at least eleven years ago. During the Great Recession, corporations and banks received federal bailout dollars close to $900 billion to help move bad loans off their books, shift mortgages to the Fed, and make low-interest loans available to companies. Consumers received no relief for the reduction of the value of their homes, triggering millions of foreclosures, with 50% or more losses to savings and retirement plans. Millions of homeowners lost significant amounts of equity in their homes.
…click on the above link to read the rest of the article…
#MacroView: The Fed Can’t Fix What’s Broken
#MacroView: The Fed Can’t Fix What’s Broken
“The Federal Reserve is poised to spray trillions of dollars into the U.S. economy once a massive aid package to fight the coronavirus and its aftershocks is signed into law. These actions are unprecedented, going beyond anything it did during the 2008 financial crisis in a sign of the extraordinary challenge facing the nation.” – Bloomberg
Currently, the Federal Reserve is in a fight to offset an economic shock bigger than the financial crisis, and they are engaging every possible monetary tool within their arsenal to achieve that goal. The Fed is no longer just a “last resort” for the financial institutions, but now are the lender for the broader economy.
There is just one problem.
The Fed continues to try and stave off an event that is a necessary part of the economic cycle, a debt revulsion.
John Maynard Keynes contended that:
“A general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn resulting in losses of potential output due to unnecessarily high unemployment, which results from the defensive (or reactive) decisions of the producers.”
In other words, when there is a lack of demand from consumers due to high unemployment, then the contraction in demand would force producers to take defensive actions to reduce output. Such a confluence of actions would lead to a recession.
On Thursday, initial jobless claims jumped by 3.3 million. This was the single largest jump in claims ever on record. The chart below shows the 4-week average to give a better scale.
This number will be MUCH worse next week as many individuals are slow to file claims, don’t know how, and states are slow to report them.
…click on the above link to read the rest of the article…
Margin Call: You Were Warned Of The Risk
Margin Call: You Were Warned Of The Risk
I have been slammed with emails over the last couple of days asking the following questions:
“What just happened to my bonds?”
“What happened to my gold position, shouldn’t it be going up?”
“Why are all my stocks being flushed at the same time?”
As noted by Zerohedge:
“Stocks down, Bonds down, credit down, gold down, oil down, copper down, crypto down, global systemically important banks down, and liquidity down…
Today was the worst day for a combined equity/bond portfolio… ever…”
This Is What A “Margin Call,” Looks Like.
In December 2018, we warned of the risk. At that time, the market was dropping sharply, and Mark Hulbert wrote an article dismissing the risk of margin debt. To wit:
“Plunging margin debt may not doom the bull market after all, reports to the contrary notwithstanding.
According to research conducted in the 1970s by Norman Fosback, then the president of the Institute for Econometric Research, there is an 85% probability that a bull market is in progress when margin debt is above its 12-month moving average, in contrast to just a 41% probability when it’s below.
Why, then, do I suggest not becoming overly pessimistic? For several reasons:
1) The margin debt indicator issues many false signals
2) There is insufficient data
3) Margin debt is a strong coincident indicator.”
I disagreed with Mark on several points at the time. But fortunately the Federal Reserve’s reversal on monetary policy kept the stock market from sinking to levels that would trigger “margin calls.”
As I noted then, margin debt is not a technical indicator that can be used to trade markets. Margin debt is the “gasoline,” which drives markets higher as the leverage provides for the additional purchasing power of assets. However, that “leverage” also works in reverse as it provides the accelerant for larger declines as lenders “force” the sale of assets to cover credit lines without regard to the borrower’s position.
…click on the above link to read the rest of the article…
Special Report: Panic Sets In As “Everything Must Go”
Special Report: Panic Sets In As “Everything Must Go”
Note: All charts now updated for this mornings open.
The following is a report we generate regularly for our RIAPRO Subscribers. You can try our service RISK-FREE for 30-Days.
Headlines from the past four-days:
Dow sinks 2,000 points in worst day since 2008, S&P 500 drops more than 7%
Dow rallies more than 1,100 points in a wild session, halves losses from Monday’s sell-off
Dow drops 1,400 points and tumbles into a bear market, down 20% from last month’s record close
Stocks extend losses following 15-minute ‘circuit breaker’ halt, S&P 500 drops 8%
It has, been a heck of a couple of weeks for the market with daily point swings running 1000, or more, points in either direction.
However, given Tuesday’s huge rally, it seemed as if the market’s recent rout might be over with the bulls set to take charge? Unfortunately, as with the two-previous 1000+ point rallies, the bulls couldn’t maintain their stand.
But with the markets having now triggered a 20% decline, ending the “bull market,” according to the media, is all “hope” now lost? Is the market now like an “Oriental Rug Factory” where “Everything Must Go?”
It certainly feels that way at the moment.
“Virus fears” have run amok with major sporting events playing to empty crowds, the Houston Live Stock Show & Rodeo was canceled, along with Coachella, and numerous conferences and conventions from Las Vegas to New York. If that wasn’t bad enough, Saudi Arabia thought they would start an “oil price”war just to make things interesting.
What is happening now, and what we have warned about for some time, is that markets needed to reprice valuations for a reduction in economic growth and earnings.
It has just been a much quicker, and brutal, event than even we anticipated.
The questions to answer now are:
…click on the above link to read the rest of the article…
Will The Corona Virus Trigger A Recession?
Will The Corona Virus Trigger A Recession?
As if waking up to an economic nightmare, investors see headlines like these and many others flashing across their Bloomberg terminals:
- Facebook says Oculus headphone production will be delayed due to virus
- Apple extends country wide store closing for another week
- Foxconn delays iPhone production
- Qualcomm cuts production forecast due to virus uncertainty
- Starbucks announces China store closures through Lunar New Year, uncertain when they may reopen
- US Steel flashes a warning of a cut in demand
- Nike shoe production halted
- Under Armour missed on sales, and their outlook is weak. They partially blamed the Corona Virus outbreak.
- IEA forecasts drop in oil demand this quarter- first time in a decade
The seemingly never ending list of delays, disruptions, and cuts rolls on from retail to high technology. Even services are impacted as flights and train trips are canceled within and to and from China. While some technology-based services are provided over the Internet service, restaurants, training, and consulting, as examples, must be performed in person. Manufacturing operations require workers to be at the factory to produce products. Thus, manufacturing is much more acutely affected by quarantines, shutdowns, transportation disruption, and other government actions.
It is as if an economic tsunami is rolling over the global economy. China’s economy was 18 % of world GDP in 2019. For most S & P 100 corporations, the Asian giant is their fastest growing market at 20 – 30 % per year. Even more critical, China has become the hub of world manufacturing after entering the World Trade Organization in 2000. Over the past two decades, U.S. corporations have relocated manufacturing to China to leverage an inexpensive labor force and modern business infrastructure.
Source: The Wall Street Journal – 2/7/20
Prior to the epidemic, world trade had begun to slow as a result of the China – U.S. trade war and other tariffs. World trade for the first time since the last recession has turned negative.
“SARS” Versus “Wuhan”: The Difference Between “Now & Then”
“SARS” Versus “Wuhan”: The Difference Between “Now & Then”
A week dominated by headlines of a spreading respiratory virus has had investors recalling pandemics past, from SARS in 2003 to the Ebola scare six years ago. While the “Wuhan” virus, or known scientifically as “nCoV,” is still in its infancy, it is closely tracking both the infection and, unfortunately, death rates of the SARS virus.
However, the question everyone wants an answer to is: “what does the virus mean for the markets?”
Will it derail the longest bull market in U.S. history? Or, is it nothing to worry about?
If you read the mainstream media, the answer seems to be the latter. To wit:
“However, gauged by the market’s performance during the onset of other infectious diseases, including SARS, or severe acute respiratory syndrome, Ebola and avian flu, Wall Street investors may have little to fear that this disease will sicken a U.S. stock market that finished 2019 with the best annual return in years and has kicked off 2020 at or near all-time highs.” – MarketWatch
With the stock market perched near all-time highs, it is understandable investors are quick to dismiss the potential ramifications of the virus very quickly. There is also plenty of anecdotal evidence to support the bullish claims as well. The chart below is the S&P 500 index versus its exponential growth trend with a history of the more important viral outbreaks notated.
Throughout history, markets have always seemed to bounce back from deadly viral outbreaks. However, long-term charts tend to obfuscate the damage done to investors who have a much shorter investment time horizon.
Currently, the more prominent comparison is how the market performed following the “SARS” outbreak in 2003, as it also was a member of the “corona virus” family.
Clearly, if you just remained invested, there was a quick recovery from the market impact, and the bull market resumed.
…click on the above link to read the rest of the article…
When It Becomes Serious You Have To Lie: Update On The Repo Fiasco
When It Becomes Serious You Have To Lie: Update On The Repo Fiasco
Occasionally, problems reveal themselves gradually. A water stain on the ceiling is potentially evidence of a much larger problem. Painting over the stain will temporarily relieve the unsightly condition, but in time, the water stain will return. This is analogous to a situation occurring within the banking system. Almost three months after water stains first appeared in the overnight funding markets, the Fed has stepped in on a daily basis to “re-paint the ceiling” and the problem has appeared to vanish. Yet, every day the stain reappears and the Fed’s work begins anew. One is left to wonder why the leak hasn’t been fixed.
In mid-September, evidence of issues in the U.S. banking system began to appear. The problem occurred in the overnight funding markets which serve as one of the most important components of a well-functioning financial and economic system. It is also a market that few investors follow and even fewer understand. At that time, interest rates in the normally boring repo market suddenly spiked higher with intra-day rates surpassing a whopping 8%. The difference between the 8% repo rate recorded on September 16, 2019 and Treasuries was an eight standard deviation event. Statistically, such an event should occur once every three billion years.
For a refresher on the details of those events, we suggest reading our article from September 25, 2019, entitled Who Could Have Known: What The Repo Fiasco Entails.
At the time, it was surprising that the sudden change in overnight repo borrowing rates caught the Fed completely off guard and that they lacked a reasonable explanation for the disruption. Since then, our surprise has turned to concern and suspicion.
We harbor doubts about the cause of the problem based on two excuses the Fed and banks use to explain the situation. Neither are compelling or convincing.
…click on the above link to read the rest of the article…
J.M. Keynes: The Time He Had A Point
J.M. Keynes: The Time He Had A Point
John Maynard Keynes once said:
“Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”
While true, it doesn’t go far enough. The problem isn’t simply defunct economists or “scribblers of a few years back.”
We are in the grip of economists who, far from being defunct, hold great power. Whether they hear voices in the air (or Twitter), I can’t say, but they are indeed madmen in authority.
Not all economists are in that category. Many provide valuable insight or are at worst harmless. They don’t pretend they can change human nature or prevent the inevitable.
Unfortunately, some economists do believe those things. Worse, they are in places from which they can wreak havoc, and they are.
Last weekend I received two emails referring me to articles about the economics profession that stirred my writing juices.
I don’t agree with everything in the articles. They are, however, important because they try, at least, to describe and possibly fix the problem Keynes identified.
We have to address them, not just economically but politically. We can’t just put our heads in the sand and think this will go away.
The whole debt bubble, the income and wealth inequality angst, a growing deficit which will get worse after the next recession, and lack of economic understanding among voters is all coming home to roost.
Better to think about that now, while we can still act and maybe even change things.
False Assumptions
The first item is a July 2019 TED talk by Nick Hanauer, a self-described Seattle “plutocrat” who founded and sold several companies.
…click on the above link to read the rest of the article…
Black Monday – Can It Happen Again?
Black Monday – Can It Happen Again?
The 1987 stock market crash, better known as Black Monday, was a statistical anomaly, often referred to as a Black Swan event. Unlike other market declines, investors seem to be under the false premise that the stock market in 1987 provided no warning of the impending crash. The unique characteristics of Black Monday, the magnitude and instantaneous nature of the drop, has relegated the event to the “could never happen again” compartment of investors’ memories.
On Black Monday, October 19, 1987, the Dow Jones Industrial Average (DJIA) fell 22.6% in the greatest one-day loss ever recorded on Wall Street. Despite varying perceptions, there were clear fundamental and technical warnings preceding the crash that were detected by a few investors. For the rest, the market euphoria raging at the time blinded them to what in hindsight seemed obvious.
Stock markets, like in 1987, are in a state of complacency, donning a ‘what could go wrong’ brashness and extrapolating good times as far as the eye can see. Even those that detect economic headwinds and excessive valuations appear emboldened by the thought that the Fed will not allow anything bad to happen.
While we respect the bullish price action, we also appreciate that investors are not properly assessing fundamental factors that overwhelmingly argue the market is overvalued. There is no doubt that prices and valuations will revert to more normal levels. Will it occur via a long period of market malaise, a single large drawdown like 1987, or something more akin to the crashes of 2001 and 2008? When will it occur? We do not have the answers, nor does anyone else; however, we know that those who study prior market drawdowns are better prepared and better equipped to limit their risk and avoid a devastating loss.
…click on the above link to read the rest of the article…
8-Reasons To Hold Some Extra Cash
8-Reasons To Hold Some Extra Cash
Over the past few months, we have been writing a series of articles that highlight our concerns of increasing market risk. Here is a sampling of some of our more recent newsletters on the issue.
- Never Hurts To Ring The Cash Register
- Looking For A Sellable Rally
- Bull vs. Bear Case
- Don’t Fear A Bear Market
- Risk Happens Fast
The common thread among these articles was to encourage our readers to use rallies to reduce risk as the “bull case” was being eroded by slower economic growth, weaker earnings, trade wars, and the end of the stimulus from tax cuts and natural disasters. To wit:
These “warning signs” are just that. None of them suggest the markets, or the economy, are immediately plunging into the next recession-driven market reversion.
However, The equity market stopped being a leading indicator, or an economic barometer, a long time ago. Central banks looked after that. This entire cycle saw the weakest economic growth of all time couple the mother of all bull markets.
There will be payback for that misalignment of funds.“
As I noted on Tuesday, the divergences between large-caps and almost every other equity index strongly suggest that something is not quite right. As shown in the chart below, that negative divergence is something we should not discount.
However, this is where it gets difficult for investors.
- The “bulls” are hoping for a break to the upside which would logically lead to a retest of old highs.
- The “bears” are concerned about a downside break which would likely lead to a retest of last December’s lows.
- Which way will it break? Nobody really knows.
This is why we have been suggesting raising cash on rallies, and rebalancing risk until the path forward becomes clear. Importantly:
…click on the above link to read the rest of the article…
The Mechanics of Absurdity
The Mechanics of Absurdity
Over the past few decades, the central banks, including the Federal Reserve (Fed), have relied increasingly on interest rates to help modify economic growth. Interest rate management is their tool of choice because it can be effective and because central banks regulate the supply of money, which directly effects the cost to borrow it. Lower interest rates incentivize borrowers to take on debt and consume while dis-incentivizing savings.
Regrettably, a growing consequence of favoring lower than normal interest rates for prolonged periods is that consumers, companies, and nations grow increasingly indebted as a percentage of their respective income. In many cases, consumption is pulled from the future to the present day. Accordingly, less consumption is needed in the future and a larger portion of income and wealth must be devoted to servicing the accumulated debt as opposed to productive ventures which would otherwise generate income to help pay off the debt.
Today, interest rates are at historically low levels around the globe. Interest rates are negative in Japan and throughout much of Europe. In this article, we expound on the themes laid out in Negative is the New Subprime, to discuss the mechanics of negative-yielding debt as well as the current mindset of investors that invest in negative-yielding debt.
Is invest the right word in describing an asset that when held to maturity guarantees a loss of capital?
Negative Yield Mechanics
Negative yields are not only bestowed upon sovereign debt, as investment grade and even some junk-rated debt in Europe now carry negative yields. Even stranger, Market Watch just wrote about a Danish bank offering consumers’ negative interest rate mortgages (LINK).
…click on the above link to read the rest of the article…
Whistling Past The $70 Trillion Debt Graveyard
Whistling Past The $70 Trillion Debt Graveyard
- Review & Market Update
- Whistling Past The $70 Trillion Debt Graveyard
- The Real Crisis Is Coming
- Sector & Market Analysis
- 401k Plan Manager
Last week, we discussed the setup for a near-term mean reversion because of the massive extension above the long-term mean. To wit:
“There is also just the simple issue that markets are very extended above their long-term trends, as shown in the chart below. A geopolitical event, a shift in expectations, or an acceleration in economic weakness in the U.S. could spark a mean-reverting event which would be quite the norm of what we have seen in recent years.”
This analysis is what led us to take action for our RIAPRO subscribers last week (30-Day Free Trial),as we added a 2x-short S&P 500 index fund to Equity Long-Short Account to hedge our longs (GOOG, CRM, NVDA, EMN, IVV, RSP) against a potential mean reversion.
“This morning, we are adding a small 2x S&P 500 short position to the trading portfolio to hedge our core long positions against a retracement over the next few weeks. We will remove the short if the market can regain its footing and move higher, or the market sells off and reaches oversold conditions.”
This is the purpose of hedging, as it reduces volatility over time, which inherently reduces the risk of emotionally based trading mistakes.
My friends at Polar Futures Group laid out the same concerns on Friday:
“The mean reversion trade: For the past few weeks I’ve been musing that the “irresistible force” that has moved all markets has been the aggressive repricing of future interest rate expectations since last November.
…click on the above link to read the rest of the article…
The $6 Trillion Pension Bailout Is Coming
The $6 Trillion Pension Bailout Is Coming
Fiscal responsibility is dead.
This past week, Trump announced he had reached an agreement with Congress to pass a continuing resolution which will suspend the debt ceiling until July 2021.
The good news is that it will ONLY increase spending by just $320 billion.
What a bargain, right?
It’s a lie.
That is just the “starting point” of proposed spending. Without a “debt ceiling” to constrain spending, the actual spending will be substantially higher.
However, the $320 billion is also deceiving because that is on top of the spending we have already committed. As I noted just recently:
“In 2018, the Federal Government spent $4.48 Trillion, which was equivalent to 22% of the nation’s entire nominal GDP. Of that total spending, ONLY $3.5 Trillion was financed by Federal revenues, and $986 billion was financed through debt.
In other words, if 75% of all expenditures is social welfare and interest on the debt, those payments required $3.36 Trillion of the $3.5 Trillion (or 96%) of revenue coming in.”
Do some math here.
The U.S. spent $986 billion more than it received in revenue in 2018, which is the overall “deficit.” If you just add the $320 billion to that number you are now running a $1.3 Trillion deficit.
Sure enough, this is precisely where I forecast we would be in December of 2017.
“Of course, the real question is how are you going to ‘pay for it?’ On the ‘fiscal’ side of the tax reform bill, without achieving accelerated rates of economic growth – ‘the debt will balloon.’
The reality, of course, is that is what will happen because there is absolutely NO historical evidence that cutting taxes, without offsetting cuts to spending, leads to stronger economic growth.”
More importantly, Federal Tax Revenue is DECLINING. Such was NOT supposed to be the case, as the whole “corporate tax cut” bill was supposed to lift tax revenues due to rising incomes.
…click on the above link to read the rest of the article…
Federal Reserve Headlines – Fact or Fiction?
Federal Reserve Headlines – Fact or Fiction?
“When it becomes serious, you have to lie.” – Jean-Claude Juncker, former President of the Eurogroup of Eurozone finance ministers
On July 16, 2019, Chicago Federal Reserve President Charles Evans made a series of comments that were blasted across the financial news wires. In the headlines taken from his speech on the 16th and other statements over the past few weeks, Mr. Evans argues for the need to cut interest rates at the July 31stmeeting and future meetings.
In this article, we look at his rationale and provide you with supporting graphs and comments that question his logic supporting the rate cuts. We pick on Charles Evans in this piece, but quite honestly, he is reiterating similar themes discussed by many other Fed members.
The issues raised here are important because the Fed continues to play an outsized role in influencing asset valuations that are historically high. As such, it is incumbent upon investors to understand when the Fed may be on the precipice of making a policy error. If asset prices rest on confidence in the Fed, what will happen when said confidence erodes?
The Fed’s Mandate
Before comparing reality with his recent headlines, it is important to clarify the Fed’s Congressional mandate as stated in the Federal Reserve Act. The entire Federal Reserve act can be found HERE. For this article, we focus on Section 2A- Monetary Policy Objectives as follows:
The stock market is at all-time highs, bond yields are well below “moderate,” unemployment stands at 50-year lows, and prices are stable. Based on the Fed’s objectives, there is certainly no reason to cut rates.
…click on the above link to read the rest of the article…
