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Mis a match

The markets were created by humans yet it seems as though we understand it less than the inalienable laws of the universe. It seems there are fewer definitive answers about a man-made creature then there are about man’s own origin. The markets are currently trading at a Price-Earnings multiple reminiscent of February, before the Coronavirus pandemic. Additionally, America is borrowing against its future growth. The Federal Reserve is taking unprecedented risk with their purchase of new asset classes and is expanding their balance sheet to impossibly large levels. All of the monetary and fiscal stimulus will inevitably slow future economic growth. It seems that the Coronavirus pandemic will not be the crisis but will set up the next one.

The only area ripe for accurate forecast is the oil market. Crude is trading at less than $18 a barrel. The drop in demand will rebound and production will follow as soon. It is literally unprofitable for most of the oil producing nations to continue production at below $10 a barrel. This offers a floor of oil prices. Additionally, the massive oversupply of the market will diminish as demand returns in the coming months. The world runs on oil and as soon as it starts running again, oil will run too.

In summation my beliefs are simple, equities are confusing, commodities are simple. Get out of equities and into oil.

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Stock up on Stocks

Equites seem to be recovering. The broader market is up almost 6 percent over the past two days. The question in everybody’s mind is: Will this trend continue? The answer looks very unclear. The Coronavirus data from New York looks positive. The rate of infection and number of hospitalizations look to be declining. While this news is encouraging, this progress requires a herculean effort which cannot be diminished if progress is to continue. This premise means that it will take a significant amount of time before the economy resumes as normal.

In Wuhan, China, where the outbreak began, the last protective measures were lifted today. The restrictions began on January 23 and continued for two months. The most optimistic timeline in the United States would be the Wuhan timeline. With America’s quarantine largely beginning on March 14, it can be reasonably assumed that these restrictions will last until May 14. However, this scenario is optimistic. To achieve such a short timeline from outbreak to recovery, China had to implement severe restrictions. In a liberal democracy like America, these restrictions are simply untenable. So what does this mean? It means that the timeline America can expect will be substantially longer, probably one to two months more than Wuhan. This extended period of social distancing will mean an additional 8 to 10 percent drop in GDP ( Gross Domestic Product). However, equity prices do not move in tandem with GDP.

So is now a good time to buy? The equity markets are pricing in a quick turnaround in consumer sentiment, which seems unlikely to materialize until a vaccine is widely deployed. People have been attacked at a visceral level. Such emotions cannot be easily overridden without an antidote to the Coronavirus. The market will probably drop 10 – 15 percent over the next month, by which time it will be clear how fast the recovery will be. The speed at which the economy returns will dictate how the economy will weather over the next few years.

The investor, who cares only for the long term, should be considered about which tools are still available in the wake of a second recession. Both the Federal Reserve and Congress have exhausted all their stimulus measures. Without ample time to reload on these stimulus measures, there is a high risk of a severe economic downturn without the cushion of stimulus. The rising corporate debt load is a bomb waiting to explode. This Coronavirus has only added to the corporate debt burden and worsened the future explosion. Companies that survive this crisis may not have much time before the next. While the Coronavirus pandemic may be the primary concern for the markets do not forget about these high corporate debt loads. They will come back to bite and they will hurt equities for a long time.

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The week ahead #2

Last weeks economic did not disappoint. The two big pieces of information last week were the 700,000 thousand jobs cut from non-farm payrolls and the 6.6 million jobless claims. Both of these numbers were previously in the realm of impossibility, yet have become a reality. This week’s data will be increasingly more dire than last weeks. As long as the economy remains in a Coronavirus induced coma, these numbers will continue to be outside anyone’s imagination.

Monday: Check updates on Coronavirus

Any news that pertains to the Coronavirus pandemic is inherently important in this time. This news has a direct impact on both the economy and consumer sentiment. Also a major contingency of investors is that the economy will magically resume after quarantine ends. This is simply fiction. People will not feel safe to return to their normal routines until a vaccine is found and widely deployed. Regardless of how deadly this virus may actually be, panic breeds panic, and people will not stop panicking until effective treatment or a vaccine is found.

Tuesday: Jobs Openings

The data that will be reported on Tuesday covers the period ending in February. Any data points coming out before the massive shutdowns in March in worthless, however, also reminiscent of the good ol’ times when everyone had money.

Wednesday: FOMC minutes

Reading what the Federal Reserve discussed will be extremely interesting. What they discussed is pertinent in understanding how the Fed will maneuver in this environment.

Thursday: Weekly jobless claims

The expectation is this number will reach the highest ever in American history. It will probably exceed 10 million up from about 6.6 million last week.

Friday: Consumer price index

Looking at the CPI is useful in understanding how many times money is still circulating, or velocity. Following the CPI in the coming months will be critical in measuring the effects of the monetary and fiscal stimulus.

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Nothing Sweeter than Capital

Ah capital. It’s such an amazing concept. A person can give his money away, to a manager without any difficulties, and reap the gains. Our society values these capital givers so much we devised a special term for them: Investors. Being an investor is a wonderful thing. Instead of working achingly long hours for menial returns, that work is done by others. Instead of seeing the product of your labor end up in someone else’s pocket book, it goes straight to your’s. Instead of breaking your back with labor, you simply wait and watch as the market delivers.

Wow, this system sounds fantastic for the people with capital, but there are many caveats. When investing in any venture, save your own, you place faith that the managers will be good stewards of your money. You also place faith in that sector of the economy and the employees behind the company. In any investment capital is as critical as faith is. It’s difficult to internalize that so much of our economic system is faith based.

Capital allocation is as dependent on understanding people as it is about understanding businesses. Balance Sheets are important only in the context of the people that manage it. It is key to remember these axioms in this time of turbulence.

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The Great Oil Recovery

Oli reached unbelievably low levels a few days, the markets seemed to agree, rebounding more than 16% today. In the past today’s oil has risen close to 40 percent. These huge gains are only the beginning. Over the next 8 months, I believe oil will outperform the broader market. Instead of having to worry about a hit to earnings or profits, the principal concern with oil is simple: Supply and Demand. These two concepts are easy to understand. Instead of worrying how employment will respond to the fiscal and monetary stimulus, all you have to worry about is a return in demand. THAT’S ALL. A much easier task then predicting macroeconomic trends. Regardless, it’s clear oil is still priced cheaper then water in some parts of the United States. That fact alone should be enough to bet on oil’s recovery.

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Oil still has room to grow

Oil closed up 17% today, on news that Russia and Saudi Arabia had agreed to cut 15 million barrels of oil a day between them. However, it increasingly looks like the president may have exaggerated how expansive the production cuts will really be. Saudi Arabia, after close, called for an emergency meeting of OPEC (Oil Producing and Exporting Countries) , to probably cut oil production further. However, the next linchpin in oil prices will be a return in demand. Even with this 17% increase in oil, it is still a fantastic time to buy. Oil is so depressed that it should return 60 – 70 percent over the next year or so. The drop in demand is not permanent and prices will rebound after Covid.

Even with this small rebound in oil prices, highly leveraged oil companies will not benefit. Occidental moved in tandem with oil prices, yet still will not benefit from them. There negative profit margin when oil was price 40% higher than it is now, means they are still not operating in the green. Without a quick turnaround in demand, which will not happen, Occidental will need to file for bankruptcy to survive. The capital markets are not kind to oil currently and highly leveraged companies, like Occidental, do not have enough room to operate within it.

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Ah, the Markets…

The markets are anyone’s game these days. Investors are now amateur virologists, attempting to predict the spread of the Coronavirus. There is sound logic behind trying to predict the spread of the disease. If the lockdown Americans are placed under lasts for an additional two months the cost to GDP would be an additional $1.6 trillion. Sure these statistics are depressing, but what’s the good news you ask. Well, Federal Reserve is lending large banks an additional $1 trillion a day to keep credit functioning smoothly. The additional liquidity should calm markets eventually. While the markets may continue to drop precipitously, all of the monetary and fiscal stimulus will eventually become reflected in Asset prices. The markets can not expect trillions of dollars in stimulus to not affect the value of securities.

Another big headline that grabbed my attention today, was a meeting of the CEOs of major oil companies meeting with the president today. The really large American oil producers like Chevron and Exxon do not require the same financial assistance as Occidental. This disparity, in need, will result in dissent and prevent a unified lobbying effort to pass a fiscal stimulus package. Occidental will not get the help they need and will go bankrupt. This is inevitable. Occidental was already an over extended company before the Coronavirus and they are unprepared for this weak economic activity. Occidental’s profit margin in the fourth quarter of 2019 was negative, and this was with an oil price 40% higher than it is currently. If oil prices remain depressed for the rest of the year, it is a certainty that they will file for bankruptcy.

Today was also the release of new motor vehicle sales. General Motors and Fiat Chrysler reported declines of 7 and 10 percent respectively. However foreign manufacturers Toyota, Honda, and Mercedes-Benz also reported declines of 30 – 50 percent. The decline of sales for American automakers will probably be significantly higher next quarter. The next quarter for American manufacturers will mirror the decline foreign automakers reported this quarter. The severe slowdown in a key part of the American economy implies a snail-pace return to growth even after the Coronavirus.

The stimulus provided by both the Federal Reserve and Government will result in inflation. It’s inevitable. The real question is if there will be a return to real economic growth. The answer to this increasingly looks like no. If we have anything to learn from history, it looks like the American economy will go through a lost decade similar to Japan’s in the 1980s.

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A Cash Strapped World

Everyone seems to need cash these days. People without any cash are resorting to bartering for goods swapping eggs for toilet paper.  Corporations are in an equally precarious position drawing down their credit lines and issuing new bonds. In this scramble for cash their will be a reckoning between haves and have-nots. Companies that are highly leveraged may not have access to the capital they need to weather the storm. Additionally, even companies with investment grade ratings are being forced to raise capital at a premium in this low-liquidity environment. For example, Exxon with a Aaa/AA credit rating issued its debt at a premium to lower-grade companies. With the Oil industry in dire straits their access to capital will come with a large premium. So which companies look well positioned for the storm. Comparing Exxon, a well capitalized company, with Occidental, a highly leveraged corporation.

The first question to ask in the time of Coronavirus is will they have enough cash to cover their losses amid lower demand, and how strong does their balance sheet look. For oil companies specifically, the question is even more acute. Oil has reached an unprecedented price which is not sustainable to many of the market participants in America. Occidental has an asset to liability ratio of 1.4, whereas Exxon as a ratio close to 2. This is one of the fundamental reasons Exxon has ample access to liquidity. With an asset to liability that is low, Occidental will not be able to raise cash at a decent price. There are long-term ramifications to raising capital at expensive levels. The high yields Occidental must offer on its new issues, the interest it pays will weigh down earning for years.

Before Exxon raised new cash, Occidental and Exxon has similar cash positions. However, Exxon is much better situated now then Occidental is for a protracted period of low oil prices. In the fourth quarter Occidental had a profit margin of -2.94% compared with Exxon’s profit margin of 3.82%. With such a huge difference in profit margin before the massive price slump, Occidental will be on the brink of collapse.

The fortitudes of these companies are incomparable. Exxon is much better suited to survive the Coronavirus pandemic and emerge as a more dominant company, than Occidental. Occidental is on the brink of collapse and it’s viability unclear. Perhaps, I’m over dramatic with regards to Occidental’s survival chances, but if you were to bet on oil rebounding do not buy Occidental.

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Run World Run

Oil dropped to its lowest level in 18 years today. This is really unfortunate if one’s whole portfolio is in oil, like your’s truly. However, these low prices must be temporary. The steep drop in demand is certainly temporary as most of the world’s population is placed under quarantine. Integrated oil and gas companies like Royal Dutch Shell, Chevron, and Exxon will benefit from this drop in price as highly leveraged players like Occidental are forced out of the market.

Another sector for further study is well capitalized refiners. Well managed companies like Valero, that depend on the price of WTI (West Texas Intermediate), are extremely underpriced. Companies that have ample cash and plenty of credit on hand should be bought at this steep discount.

Another opportunity for investors is in Solar Panel manufacturers. The steep drop in oil prices has changed the economics of energy, putting green energy in a very precarious position. Given the pull-back in P/E multiples, green energy, like solar panel manufacturers, has reached an attractive price.

While many people are focused on the general stock market, energy is priced very attractively. Given this huge temporary decline in oil consumption, these equities are sure to rebound in a matter of months as demand increases again. The world runs on oil, as soon as the world starts again, oil stocks will run too.

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The week ahead #1

The problem with the markets is that the Coronavirus is not some abstract financial tool, but instead a deadly virus that can affect people’s loved ones. This personal fear is not only contagious but will continue to play into investors and speculators psyche. Hearing ambulances in your neighborhood, around the clock, makes the threat seem incalculably close. Such fear will continue to force markets downwards and rightfully so.

Some new pieces of economic data will be released this week illustrating how damaging the Coronavirus lockdowns have been.

Monday:

The principal focus on Monday, will be updates on the Coronavirus. Considering the worsening condition of many American cities, the markets will almost certainly open lower. Additionally, Donald Trump extended the federal quarantine guidelines until April 30. This action is a clear reversal to the “reopening of America” by Easter, that the markets had already priced in.

Tuesday:

The Consumer confidence index will be released on Tuesday and is expected to be positive. This report will cover data from March, and will be one of the first pieces of economic data illuminating the effect of Coronavirus on the American consumer. The trends delineated by this report will dictate how fast the economy will recover. Another interesting piece of data is the Chicago Purchasing Managers’ Index (PMI). This report will speak to the health of the manufacturing sector in the Chicago region. It will be interesting to see how much slower industrial production is since the beginning of the outbreak.

Wednesday:

While many news outlets will be focusing on the employment report which will tell us how many non-farm jobs were added to payroll, I am personally more interested in Motor vehicle sales. Seeing how robust vehicle sales are for March, will give us a rough picture of how Ford, General Motors, and Tesla will be able to weather the storm. Tesla has an extremely leveraged balance sheet and without revenue Tesla will be pushed to the brink.

Thursday:

Weekly jobless claims and factory orders for the February period are expected on Thursday. Weekly jobless claims are expected to hit 4.0 million topping the previous record of 3.28 million set last week. These jobless claims will most likely balloon to more than 13 million by June. Considering these huge increases another stimulus package is inevitable. Also, Congress has enabled the Federal reserve to use its infinite balance sheet to lend to areas of the economy where liquidity has dried up. This reverses precedent set during the ’08 recession underlying how serious the crisis is becoming.

Friday:

After a long week of volatility, by both the crazy numbers from the days before and updates on the Coronavirus we can expect the Unemployment rate and the ISM non manufacturing index. With a previously low unemployment rate we can start realizing the beginning of record high rates in the near future. Another supposedly “cyclical” report is the ISM non manufacturing index. This index measures employment trends, prices, and new orders in non-manufacturing industries. With this data it’ll be clear to see how fast the service industry is contracting.

All of this data comes at a time when we as a society have decided money is worthless and lives matter more than livelihoods. It is a tremendous time to see people, governments, and society collectively choosing humanity over human fiction.