Monthly Archives: March 2020

an ugly day: coronavirus + oil

March 9, 2020 By in coronavirus, Current Market Thoughts, oil, shale oil, Strategy, Uncategorized Tags: , , , 6 Comments

oil

In normal times, the world produces about 100 million barrels of oil daily and consumes about the same amount.  Small changes in either supply or demand can cause huge changes in price.  That’s because demand–autos, jet fuel, heating oil…is relatively inflexible (if seasonal).  Supply is also inflexible, because a cartel of suppliers, led by Saudi Arabia has been able to control output levels.  Their goal:  highest price possible without encouraging substitution.

A problem has surfaced, however.  A mild winter + reduced demand from airlines have combined to cause a potential supply overhang.  Negotiations between Saudi Arabia and Russia about production cuts to offset this and keep prices high broke down.  Not only that, but the Saudis have apparently decided to punish Russia (and themselves) by starting to sell large amounts of oil at about $30 a barrel, or $10 a barrel below Friday’s price.

Implications:

–the consensus view is that Saudi Arabia, radically dependent on oil exports, needs a price of $80+ to balance its budget; Russia, smaller and economically much weaker, needs $40+.  So both are it trouble.  Riyadh’s calculation must be that Moscow will soon feel the pain more quickly and will agree to production cuts

–a $30 price has two bad consequences for oil production companies in the US and elsewhere.  The lower price reduces revenues and profits.  This is an acute problem for some US shale companies, which have borrowed heavily in the junk bond market.  In addition, a standard way of evaluating natural resource companies is to compare the stock price with the per share value of the reserves they hold.  The price fall not only reduces the value of those reserves but also shrinks the amount, since some oil that’s viable at $40 becomes economically unfeasible to drill for at $30.

–if oil companies make up 4% of the S&P 500 and we say that they have lost a third of their value over the weekend, then the S&P should open 1.2% lower because of that.  Add in banks that will be in trouble and maybe that figure drops to down 2%.  Conceptually offsetting that would be the benefit to oil consumers of lower prices.  But that’s a diffuse group that is typically overlooked in a market downdraft   …and in this case prime beneficiaries like transport companies are being hit by coronavirus fears.

–as I’m writing, the S&P 500 is trading down about 5% in the premarket.  So the other 3% must be due to other factors–presumably coronavirus fears.  Those, in turn, break out, I think, into two factors:  the virus itself and the efforts of the Trump administration to prevent disease preparedness, information exchange and treatment.  To my mind, the last is the scariest part.

–if we were to posit no AI involvement in the premarket decline, this would look to me like the start of an old-fashioned selling panic.  In an AI-driven world, however, it’s not clear that that the idea of a cathartic release of pent-up fear setting the emotional stage for the next upswing still holds water.

All in all, for almost everyone a day to turn off the screen and go out in the sunshine.

dealing with market volatility

March 6, 2020 By in correction vs. bear market, Current Market Thoughts, major changes in market direction, market bottoms, market tops, stock market, Strategy, Uncategorized Tags: , , , , , Leave a comment

Beginning rant:  finance academics equate volatility with risk.  This has some intuitive plausibility.  Volatility is also easy to measure and you don’t have to know much about actual financial markets.  Using volatility as the principal measure of risk leads to odd conclusions, however.

For example: Portfolio A is either +/- 1% each week but is up by 8% each year; Portfolio B almost never changes and is up by 3% every twelve months.

Portfolio A will double in nine years; Portfolio B takes 24 years to double–by which time Portfolio A will be almost 4x the value of B.

People untrained in academic finance would opt for A.  Academics argue (with straight faces) that the results of A should be discounted because that portfolio fluctuates in value so much more than B.  Some of them might say that A is worse than B because of greater volatility, even though that would be cold comfort to an investor aiming to send a child to college or to retire (the two principal reasons for long-term savings).

more interesting stuff

–on the most basic level, if I’m saving to buy a car this year or for a vacation, that money should be in a bank account or money market fund, not in the stock market.  Same thing with next year’s tuition money

–the stock market is the intersection of the objective financial characteristics of publicly-traded companies with the hopes and fears of investors.  Most often, prices change because of human emotion rather than altered profit prospects.   What’s happening in markets now is unusual in two ways:  an external event, COVID-19, is causing unexpected and hard-to-predict declines in profit prospects for many publicly-traded companies; and the bizarrely incompetent response of the administration to the public health threat–little action + suppression of information (btw, vintage Trump, as we witnessed in Atlantic City)–is raising deep fears about the guy driving the bus we’re all on

–most professionals I’ve known try to avoid trading during down markets, realizing that what’s emotionally satisfying today will likely appear to be incredibly stupid in a few months.  For almost everyone, sticking with the plan is the right thing to do

–personally, I’ve found down markets to be excellent times for upgrading a portfolio.  That’s because clunkers that have badly lagged during an up phase tend to outperform when the market’s going down–this is a variation on “you can’t fall off the floor.”  Strong previous performers, on the other hand, tend to do relatively poorly (see my next point).  So it makes sense to switch.  Note:  this is much harder to do in practice than it seems.

–when all else fails, i.e., after the market has been going down for a while, even professionals revert to the charts–something no one wants to admit to.  Two things I look for:

support and resistance:  meaning prices at which lots of people have previously bought and sold.  Disney (DIS), for example, went sideways for a number of years at around $110 before spiking on news of its new streaming service.  Arguably people who sold DIS over that time would be willing to buy it back at around that level.  Strong previous performers have farther to fall to reach these levels

selling climax:  meaning a point where investors succumb to fear and dump out stocks without regard to price just to stop losing money.  Sometimes the same kind of thing happens when speculators on margin are unable to meet margin calls and are sold out.  In either case, the sign is a sharp drop on high volume.  I see a little bit of that going on today

 

more on Monday

 

Keeping Score for February 2020

March 3, 2020 By in Analyzing performance, Current Market Thoughts, Keeping Score, performance attribution, performance measurement, Recent Market Action, securities markets, Strategy, Uncategorized Tags: , , , , , , Leave a comment

I’ve just updated my Keeping Score page for February and year-to-date.  What a strange time!

margin calls

March 2, 2020 By in Current Market Thoughts, Margin, margin trading, Uncategorized Tags: , , , Leave a comment

When I looked at my Fidelity account this morning I saw two odd things:  a simplified interface, and a message sent to everyone with a margin account (my wife and my joint account with Fidelity is a margin account, although we don’t trade on margin).  The message was essentially a warning to be on the alert for potential margin calls.

I’ve never seen this before.  A caveat:  until I retired at the end of 2006 all the family money was in the mutual funds I was managing, in whatever vehicle my employer required.  Still, I didn’t see this in 2008-09.

Two conclusions:

–Fidelity is anticipating/seeing volume increases that are testing the limits of its software (probably mostly an issue of private-company-esque aversion to spending on software infrastructure)

–more interesting, aggregate equity in the accounts of its margin customers must be dangerously (for the customers) low.  Margin-driven selloffs are typically ugly–and very often mark a market bottom.  Here’s why:

margin trading

In its simplest form, a market participant establishes a margin portfolio by investing some of his own money and borrowing the rest from his broker.  He pays interest on the margin loan (Fidelity charges 5% – 9%+, depending on the amount) but all of the gains/losses from the stocks go to him.  The client does relinquish some control over the account to the broker.  In particular, the broker has the right to liquidate some/all of the portfolio, and use the proceeds to repay the loan, if the portfolio value minus the loan value falls below specified levels.

Before liquidating, the broker tells the client what is going to happen and gives him a short period of time to put enough new money (securities or cash) into the account to get the equity above the minimum amount.  This is a margin call.

If the client doesn’t meet the call, the broker begins to sell.  The broker has only one aim–not to get the best price for the client but to convert securities to cash as fast as possible.  Of course, potential buyers quickly figure out what’s going on and withdraw their bids.  Carnage ensues.

That’s what Fidelity was saying we’re on the cusp of this morning.

There are some very shrewd and successful margin traders.  Around the world, though, retail margin traders are regarded as the ultimate dumb money.  That’s why seeing forced selling from these portfolios is typically seen as a very positive sign for stocks.

 

 

 

depreciating the dollar

March 2, 2020 By in administration economic strategy, currency effects, currency markets, deprecating currency, economics, macroeconomics, reserve currency, Strategy, Trump's economics, Uncategorized Tags: , , Leave a comment

When a country is having economic problems–slow growth, outdated industrial base, weak educational system, balance of payments issues–there are generally speaking two ways to fix things:

–internal adjustment, meaning fixing the domestic problems through domestic government and private sector action, and

–external adjustment, meaning depreciating the currency.

The first approach is the fundamentally correct way.  But it requires skill and demands a shakeup of the status quo.  So it’s politically difficult.

Depreciating the currency, on the other hand, is a quick-fix, sugar-high kind of thing, of basically trying to shift the problem onto a country’s trading partners.  The most common result, however, is a temporary growth spurt, a big loss of national wealth, and resurfacing of the old, unresolved problems a few years down the road–often with a bout of unwanted inflation.  The main “pluses” of depreciation are that it’s politically easy, requires little skill and most people won’t understand who’s at fault for the ultimate unhappy ending.

Examples:

the Great Depression of the 1930s;

the huge depreciation of the yen under PM Abe, which has impoverished the average Japanese citizen, made Japan a big tourist destination (because it’s so cheap) and pumped a little life into the old zaibatsu industrial conglomerates.

 

It’s understandable that Donald Trump is a fan.  It’s not clear he has even a passing acquaintance with economic theory or history.  And in a very real sense depreciation would be a reprise of the disaster he created in Atlantic City, where he freed himself of personal liabilities and paid himself millions but the people who trusted and supported him lost their shirts.

Elizabeth Warren, on the other hand, is harder to fathom.  She appears to be intelligent, thoughtful and a careful planner.  It’s difficult to believe that she doesn’t know what she’s supporting.