drinking bleach and the S&P

Last Thursday, speaking in his position as President of the United States (ex cathedra, as it were), Donald Trump said that injecting disinfectant into a patient’s body might be a good treatment for coronavirus.  He’s not a doctor, but he has a good mind; implicitly, how hard could it be? He later excused his remarks by saying he was being “sarcastic.”

“Drinking bleach” is an apt metaphor for the Trump presidency, if not for Donald Trump’s career as a whole.  There isn’t the slightest hint that Trump isn’t serious in offering this “advice.”  The message is vintage Trump. It’s pithy; it’s easy to understand.  It’s also loony. And like almost anything Trump is associated with, it’s most damaging to those who trust and support him.

( side notes: even rookie managers know never to use irony on the job, because of the very real risk of being taken literally.  Also, Trump has no clue (consciously, at least) what the word sarcasm means (i.e., “words to wound,” intended to taunt, demean or otherwise injure the addressee).)

This frightening performance comes as domestic coronavirus casualties have exceeded total US deaths from the Vietnam War and are approaching 10x those from Middle East conflicts. The Trump camp is now embarking on a chillingly Stalin-esque attempt to revise history and cast blame for his months-long coronavirus denial on Alex Azar, his Secretary of Health and Human Services.

 

As regular readers will know, my view is that Trump has done a lot to damage the long-term economic prospects of the US–deficit-inducing but useless tax cuts for the ultra-rich, the attack on the Federal Reserve, undermining the domestic auto industry, weaponizing–with the risk of ultimately disenfranchising–the US banking and capital markets systems, halving GDP growth potential by attacks on immigration, pardoning military criminals, punishing loyal officers…

Last Thursday marks a new low, though.  It was like seeing the home team’s ace pitcher taking the mound.  He’s a career minor leaguer with a checkered history.  You fret about his fastball and his control.  But these end up not being issues, because he’s lost so much arm strength that he can’t throw far enough to get the ball to the plate.

 

How can the stock market be going up after this?  Two reasons:

–we saw the man behind the curtain last week, so there probably are no more negative surprises there

–the economy is in the earliest stages of opening up again.  This is not to say COVID-19 is in the rear view mirror.  It’s a judgment that the health care system will be able to manage the level of future infections.  In typical fashion, Wall Street is beginning to sort through the debris of cruise ships, hotels, restaurant chains…to separate potential economic rebound winners from losers.

 

 

 

 

 

 

an ugly day…

…but this sort of stuff happens.

I don’t think today’s decline is about oil or Donald Trump or the pandemic.

The 2020 low (so far) occurred about a month ago.  If we’re going to return to “test” those lows, now would be about the time, based on past occurrences, when the market would flatten out and begin to drop.  This may be the first step down that path.

There is an alternate pattern, which I’ve been thinking about a lot since hearing the double bottom thesis being almost universally accepted.  It’s the somewhat older idea that the market pulls out of a nosedive when policy measures are put in place to address the problem that has been forcing the market down.  There’s an initial anticipatory rally, followed by sideways movement until the market gets hints that corporate earnings are beginning to improve.  That’s when a sustained upward market movement starts.

We’ll have a better idea in the next couple of weeks whether this market is following either of the two patterns.

An aside, sort of:  I read newspapers online from the US, the UK, Germany and Japan every day.  Well, at least the headlines and I catch up on the weekends.  I’ve noticed a significant increase in the number and bluntness of negative press comments about Mr. Trump and those who surround him, on two fronts:  that local leadership may be totally inept, but at least it’s better than Trump; and growing dismay at his white racism and his constant lying.

We’ve already seen the economic damage he is doing to the country reflected in the 15% fall in the Russell 2000 since his inauguration (with the lion’s share of the pain inflicted on his supporters (vintage Trump, in my view)) vs. a 50%+ gain for NASDAQ.  If there were an obvious alternative to Wall Street, I think we would already be seeing multiple contraction as well.

 

If I’m correct, investors like us are facing an unusual conceptual decision:

we’ve already had a short back-from-Chapter 11 rally among domestic firms hurt by the fact of the coronavirus and by the continuing bungling of the Trump administration.  At some point there must be a market move to sell winners in order to pick and choose among this wreckage.  On the other hand, the more Trump we have the more damage to the second group–therefore the shallower and shorter-lived any bounce will be.

Taking a somewhat longer-term view, given that the Democrats have yet to address any of the social issues that caused ordinary citizens in rural America to choose Trump–poor schools, jobs, medical care…–it’s at least thinkable that he will be reelected.  If so, London and Hong Kong may look like better bets than Wall Street.

My instinct at this point is to get ready to buy hotels and maybe restaurants but to wait before acting to see how the overall market will develop over the next couple of weeks, as well as whether the rush to reopen some states will turn into the medical disaster many fear.

 

 

 

oil at $10 a barrel

In my early stock market days, one of my bosses sent me on a tour of commodity-trading centers to get me up to speed on palm oil.  This was so I would understand the plantation stocks in Malaysia.  I mentioned to one head of trading I spoke with that my trip was part of a months-long project.  He looked at me like I was an idiot and slowly (so that even I could understand) explained that commodities were all about gut instinct and decisive action.  He hired good high school athletes, not scholars.   A classic jock vs. nerd confrontation.

This is to say that I’m not a commodities expert.  So maybe you should take my comments about crude oil with a grain of salt.  Anyway,

–crude for May delivery plunged over the weekend to right around $10.  On Friday April 3rd a barrel was going for $28+

–the main reason is that oil production is still miles ahead of oil use and there’s no easy way to store excess crude oil output

–this is an epic low in inflation-adjusted terms.  Saudi crude sold for less than $3 a barrel in dollars of the day in the early 1970s and rose to close to $30 in 1979-80, before plunging to $8 (about $27 in today’s dollars) in the recession that followed

–there would be an arbitrage opportunity if there were storage, since crude for August delivery is trading just under $30

–this is where my not knowing oil trading hurts:  I would have expected that future months would have collapsed in line with the current month.  I read this as traders thinking the May situation is a temporary blip, but I really don’t know

–for many years natural gas has sold at a substantial discount to crude, on a heating value basis.  Today they’re roughly equal.

my stock market take

The oil market is saying this is a temporary blip.  I’m not so sure.  But I don’t know.  And the energy sector is so small that I don’t need to do any more than observe.  So I’m going to sit on my hands.

If it persists, this situation is very bad for third-world countries like Venezuela or Russia that are radically dependent on oil.  It’s also not good for the oil countries of the Middle East, which have similarly one-dimensional economies.  They can likely continue to produce at a profit even at today’s price, but I’d expect that their governments would be forced to begin to liquidate their foreign investments as budget deficits soar.  This could have a negative effect on global stock and bond markets.

The largest effect on the US is a redistribution of wealth away from the big hydrocarbon-producing states to the consuming ones.  In theory, this should be an overall wash.  But since there’s very little discretionary driving going on, I think it’s a mild negative.

The price fall is good for the EU and most of Asia.

The US stock market is flattish, despite the oil price.  Both NASDAQ and the Russell 2000 are up slightly, suggesting that neither industries of the future and small business will be hurt by lower oil.  Even the Dow, which is showing its deep roots in industries of the past, is only down by about a percent.

An addendum (stuff I just found out):  the May crude contract expires tomorrow.  The holder is required to take physical delivery of 1,000 barrels/contract.  The price shows virtually no one wants to do so.  Apparently, it’s not clear whether storage will be available on settlement date.

contract closing:  the May crude oil contract closed today at minus $37+, meaning that the seller had to pay the buyer $37,000 to shoulder the burden of taking delivery of the 1,000 barrels each contract represents.  The buyer gets the oil plus the money.

 

 

most of an email from Wednesday night

 I think we won’t really begin to know how bad things are going to be before we see companies report earnings for 1Q20 over the next few weeks.  And it may not be until we get well into 2Q20 that we’ll have a solid grip on what the situation is.  That’s when we’ll be able to assess whether the market has already discounted all the possible bad news.
We can already figure out stuff that should be avoided–cruise ships, department stores, airlines, the Detroit auto companies…
If a professional manager has to remain close to fully invested, meaning no more than 10% in cash (for a pension manager, the maximum cash percent will typically be stipulated in a contract), just avoiding the losers will probably be enough to do better than the market.
For me, I think the investment focus should be narrower.  I find techy businesses with worldwide appeal and little investment in physical plant and equipment are especially attractive.   This is partly because technological change is very rapid, partly because I think the Trump back-to-the-Fifties economic strategy is already doing huge long-term harm to the US economy.  If he or someone like him continues in office, I think the ability of a company to pick up roots quickly and move to, say, Canada will be a distinct plus.  I also think this flight capital idea is already being factored into stock prices (look at NASDAQ  +50.8% vs Russell 2000 -13.6% since Trump has been in office).  I wouldn’t just distribute money across the board in the -non-losers.  I’d emphasize what I think are the long-term winners.
I’m sure that there are some people buying NVDA, NFLX and ATVI not because they believe in them or even know much about them but purely to defend themselves from the possibility that conventional consumer names will have hugely bad earnings performance over the next couple of quarters.  They may not be table to quantify how bad but they’re convinced that there won’t be any positive surprises, only potential negative ones.
Assuming I’m right in what I’ve written so far, the key question for me is when/how does this market situation reverse itself.
Reversal typically comes in one of two forms: the price difference between the good stocks and the bad stocks will get so extreme that, purely on valuation, the bad stocks will start to catch up with the good ones–this is a “counter-trend rally” and tends to be short; or the economy will begin to improve and there will be a genuine reversal of relative economic momentum toward business cycle recovery stocks.  I agree we’re a long way off from that.  At some point, though, it will be right to shift holdings to more traditional cyclical names in anticipation.
To some degree, the first thing has happened already.   MAR, for example was $150 in mid-December, then $46 a few weeks ago, and is now $80.  So it’s up by almost 75% from the low.  I don’t know what will happen from here but I might be tempted at $60 to buy a little bit.  Generally speaking, though, I think this kind of stock will be lucky to go sideways between now and the time, late this year?, that we get signs that business is recovering.  I’m really not accustomed to thinking about ETFs but a hotel ETF might be the better way to go.

oil below $20 a barrel

The Energy sector of the S&P 500 makes up 2.8% of the index, according to the S&P website.  This is another way of saying that none of us as investors need to have an opinion about oil and gas production, which makes up the lion’s share of the sector.

Last weekend Saudi Arabia and Russia, with a fig leaf provided by the US for Mexico’s non-participation, led an oil producers’ agreement to cut production by around 10 million barrels daily.

Prior to the meeting, crude had rallied from just over $20 to around $23.  Right after, however, the Saudis announced price discounts reported to be around $4 barrel for buyers in Asia.  Prices were reduced by a smaller amount in Europe but went up for US customers–apparently at the Trump administration’s request.  That sent crude prices into the high teens.

Why is this the best strategy for Saudi Arabia?

The commonsense answer is that Riyadh thinks it’s more important to secure sales volumes than it is to be picky on price.  This is at least partly because the world output cuts reduce, but by no means eliminate, the oversupply.  So there are still going to be plenty of barrels looking for a buyer.  Another reason is that since demand has dried up the Russian ruble has dropped by 20%.  That’s like a 25% local currency price increase for Russian crude, meaning lots of room for Moscow to undercut rivals.

investment implications

The most leveraged play to changes in oil prices is oilfield services.  Companies that specialize in exploration–seismic services, drilling rig firms–are the highest beta, firms that service existing wells less so.  During the oil price crash of the early 1980s, however,  drilling rigs were stacked for a decade or so.  On the other hand, oilfield services firms are the ultimate stock market call on rising oil prices.

Given that US hydrocarbon output and usage are roughly equal, the country as a whole should be indifferent to price changes (yes, it’s more complicated, but at this point we want only the general lay of the land) rather than the net winner it was 15 years ago.  However, within the country oil consumers normally come out ahead, while oil producers are losers.

Typically, the resulting low gasoline prices would be a boon to truckers and to commuting drivers.  The first is probably still the case, the second not so much.

The bigger issue, I think, is the fate of the Big Three Detroit auto producers, who are being kept afloat by federal government policies that encourage oil consumption and protect high-profit US-made light trucks from foreign competition.  While nothing can explain the wild gyrations of Tesla (TSLA) shares, one reasonable interpretation of the stock’s resilience is the idea that the current downturn will weaken makers of combustion engines and accelerate the turn toward electric vehicles.

Personally, I’m in no rush to buy TSLA shares–which I do own indirectly through an ARK ETF.  But it’s possible both that Americans won’t buy new cars for a while (if gasoline prices stay low, greater fuel economy won’t be a big motivator).  And the rest of the world is going electric, reducing the attractiveness of Detroit cars abroad, and probably making foreign-made electrics superior products.

If there’s any practical investment question in this, it’s:  if the driving culture in the US remains but the internal combustion engine disappears, who are the winners and losers?

 

 

 

 

 

 

 

 

Tesla and the efficient markets hypothesis

The Efficient Markets Hypothesis is an academic theory that posits that the optimal portfolio is an index fund.  There are different flavors of EMH but the general idea is that all relevant information about all stocks is virtually instantaneously factored into prices.  Therefore, it’s impossible for any investor to beat the index return.

The evidence in support of the theory is that almost no one who manages money for others and publishes legitimate results has an index-beating record.  Of course, the traditional brokerage strategy has been to build a strong sales force to gather fee-generating assets and to hope that performance takes care of itself.  So beating the market has never been a top goal.  I think that strategy is changing now, as younger and more savvy clients appear on the scene.

It seems to me that year-to-date performance of any US stock provides a counterexample to EMH.  I’ve been particularly impressed, if that’s the right word, about Tesla (TSLA).

 

On January 24th, TSLA closed at $564

By February 19th, 18 trading days later, the stock rose by 61% to $917

On March 18th, 20 trading days later, TSLA had fallen by 61% to $361.

By yesterday, another 20 trading days had passed and TSLA was up by 104% to $734.

So in the space of three months, a buyer at the close on 1/24 would have been:  up 61%, then down by 35% and is now up by 30%.

 

One side effect of EMH–its real purpose?–is that it legitimizes having tenured university finance faculties totally devoid of any practical investing, or even general capital markets, experience.  Other than the lack of respect, this suits professional investors fine.  Who needs extra competition.

 

 

 

 

 

energy: oil

history

–oil began replacing coal as fuel of choice in the early 20th century, but that loss was mostly offset by substitution of coal for wood, until…

…at the end of WWII, Saudi Arabia, having lost its primary source of revenue, Hajj pilgrims, in the prior decade-plus, opened its oil deposits to foreign development.  

–Third-world producing countries formed OPEC in 1960 as a political organization to battle exploitation by oil-consuming countries.  In the 1970s, OPEC “shocked” the world by raising the price of crude oil in two stages from $1 barrel to $7.  In the panic that ensued after the second increase the price spiked to over $30 before collapsing and staying low for years.

–During the 1970s oil crisis, every major consuming nation other than the US acted decisively to decrease dependence on oil.  If anything, the US did the opposite.  One result of our misguided policy (to protect domestic auto firms) has been that although the US represents 6% of the world’s population it consumes 20% of global oil output.  Another, despite this + trade protection of domestic carmakers, has been loss of half the domestic auto market to better-made, more fuel-efficient imports.  (In most cases this is what happens–protection weakens the protected sector.)

supply/demand

price dynamics

Pre-pandemic, the world was producing about 100 million barrels of oil daily.  It consumed about the same.  Oil supply is relatively inflexible.  In over-simple terms, once a large underground pool of oil start to flow toward a well, it’s difficult to stop without harming its ability to start up again.  Because of this, even small supply excesses and shortfalls can induce sharp price changes.

supply

The biggest oil producers are:

US          19.5 million barrels/day (includes natural gas liquids.  crude alone = 12.7 million)

Saudi Arabia          12 million

Russia          11.5 million

Canada, China, UAE, Iraq, Iran      each 4 – 5 million

demand

The biggest oil consuming countries are:

US          20 million barrels/day

EU          15 million

China          13.5 million

India, Japan, Russia      each about 4 million

my stab at production costs (which is at least directionally correct)

Saudi Arabia        less than $5/barrel

Russia          $30/barrel

US fracking          $40/barrel

where we stand toady

The coronavirus outbreak appears to have reduced world oil demand by about 15 million barrels a day.  Enough surplus oil is building up that global storage capacity will soon be completely full.  Also, a spat broke out between Saudi Arabia and Russia over production cutbacks to support prices.  When the two couldn’t agree, the Saudis began to dump extra oil on the market.

West Texas Intermediate, which closed last year just above $60 a barrel, plunged to just above $20 a barrel in late March.  It goes for about $24 as I’m writing this late Sunday night, despite Moscow and Riyadh seemingly paving patched up their differences last week and agreeing to cut their output by 10 million barrels between them.  The market was not impresses, as the Friday WTI quote shows.

fracking

The US is in a peculiar position:

–the administration in Washington appears to have two conflicting energy goals:  to keep use of fossil fuels as high as possible; and to keep the world oil price high enough to make fracking profitable.  The first argues for lower prices, the second for higher.

–according to the Energy Information Administration, fracking accounted for 7.7 million barrels of daily crude oil liftings in the US last year, or 63% of the national crude total.   If the cost numbers above are anywhere near accurate, domestic frackers are in deep trouble at today’s oil price  

This doesn’t mean production will come to a screeching halt. 

The industry has two problems:  excessive debt and high total costs.  According to the Wall Street Journal, Whiting Petroleum, a fracker who recently declared bankruptcy, prepared for pulling the plug by drawing its full $600 million credit line, swapping stock in the reorganized company to retire $2 billion in junk bonds and paying top executives a total of $14.5 million.  That solves problem number one. 

As to number two, total costs break out into capital costs (leases, drilling…) and operating costs.  I have no idea what the split is for Whiting and I have no interest in trying to figure it out.  My guess is that the company can generate positive cash flow even at today’s prices.  Almost certainly the reorganized company can.  It may choose to shut its existing wells in the hope of higher prices down the road.  But it could equally well opt to continue to operate just to keep experienced crews together.  However, new field development is likely off the table for now.

my take

When I was an oil analyst almost (gulp!) a generation ago, the ground level misunderstanding the investment world had about OPEC was the belief that it was an economic organization, a cartel, not the political entity that it actually was.  The difference?–economic cartels invariably fail as members cheat on quotas; political groups have much more solidarity.  Today’s OPEC, I think, is much more an economic cartel than previously.  In other words, it can no longer control prices.  And despite the fact that Putin and MSB have extraordinary sway over the administration in Washington, my guess is this won’t help, either.

There’s some risk that investing in oil today is like investing in firewood in 1900 or coal in 1960.

Despite this, for experts in smaller US oil exploration companies, I think there will be a lot of money to be made after a possible wave of bankruptcies has crested.  Personally, I’d rather be making videos.