Good Morning.. I am a little surprised to see stocks higher this morning after a weak close on Wall St and oil is lower again too. I am suggesting a small shot in S&P here and think we may see a test of 2400 in time. I would look to start small and add. This should keep the USD bid. To my mind the signals are all there if one wishes to look (see below). Oil is not a temporary, technical blip, it is a clear signal of just how severe this slowdown is and there is no precedent for this so trying to “look through” the issue seems somewhat of a gamble to me and not one I am prepared to take. The USD is another signal of stress and so too the funding markets still and US 5yr yields hit an all-time low. If ever there were signs of a deep and meaningful risk aversion period then look no further. We saw a steep bounce in EURGBP yesterday which on a technical basis was what I was looking for as the move had stalled. Both the UK and the EU face some tough times ahead with the UK re-starting Brexit talks and the ECB having to do more to limited effect. Italy has its rating reviewed by S&P on Friday!! Not much data today but EU consumer confidence and CAD CPI may be of note. I also think AUD is a bit rich up here..

Keep the Faith..

Details 22/04/20

June Oil contracts feel the pain. Stocks surely waking up to the risks. The ECB will have to do more. Small short S&P.

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The stress in oil was expected by many to end as the May contract rolled off and expired but June showed that the problem has not gone away and some serious oil experts feel there may be further pain ahead. At one point we saw WTI for June delivery more than halve, a day after the May contract traded below zero by some margin. The stress is clear to be seen and is NOT an exclusive problem for the oil markets; this goes so much deeper than that. It is now blatantly clear that the blowout in the May contract was more than just a technical blip and reflected growing concern that US storage facilities will fill up unless energy demand quickly rebounds from its coronavirus-related collapse. The chances of that seem slim. Meanwhile, stocks turned lower and quite rightly too as many risk signals seem to be flashing red, as indeed discussed yesterday. The USD rebounded back above 100.15, which is a level I see as something of a pivot and this pressed hard on the EM space yet again. Mexico surprised and cut rates 50bps as the economy tumbles into the abyss.

They will not be alone down there. To be honest, I think stocks still take all this rather lightly. Part of the problem is that the demand shock is far greater than the OPEC+ proposed cuts and there is still a shortage of storage space.

Pierre Andurand, one of the world’s best-known hedge fund managers specialising in oil, not only cashed in on the fall but had some bad news for those buying the dip. “We’re going to go through an economic depression, with a very large amount of unemployment that will last longer than most people expect.” He is right and oil demand may take a while to get back up to a level that matches supply. The Fed is doing everything it can but right now it is NOT buying oil. Do equity investors need more of a stark signal that the global economy is in deep stress? Is this really something we can “look through” with rose-tinted glasses and say “it will be OK in a month or so”? I am sorry; I don’t think so. This is just one of a number of signals that I have pointed out over the last few days and yesterday we also saw US bonds catch a risk aversion bid with the US 5yr yield making an all-time low; 10s lost 6bps and traded below .56% at one point. As an article in the FT suggested: Anyone still buying the dip in risky assets and refusing to hear the argument for another leg lower, should listen out for the dull thud of oil traders banging their heads on their desks. Ha-ha; not bad for the FT.

The other flashing signal to add to the others mentioned yesterday and the further losses in oil futures, was something called General Collateral. Repo GC rates began trading in the negatives in the morning (on Monday) and traded as low as -.25% on Monday afternoon. Unless there is a crisis or it’s quarter-end, it’s very rare for Repo rates to trade this negative. While the underlying reasons for GC repo’s slide into negative remain unclear, Zoltan Pozsar at CS warned that the surge in Bill issuance could become the next crisis, warning that the only way to control the short end would be to launch yield curve control for the entire yield curve. Is this an early warning of what is coming? To be honest, I do not know enough about General Collateral products but it is a part of the plumbing and a risk.

I am not sure this should be happening with all the Fed has done.

Then we come back to earnings and I am sorry but I just cannot see the upside for many. Yes, there are individual stocks that will do well out of this; there always is but the carnage will happen. This is an unprecedented slump at record speed and it is not something than can easily be balanced by monetary policies. The consumer is still the most important factor in most developed economies and the consumer is not going to pop out anytime soon and spend on non-essentials. Equity investors seem to be looking past this potential impact before it has happened. Corporate profit margins, as mentioned here before, are about to collapse.

This is so much more than a fall in oil. It is also exports, which account for about 40% of corporate profits overall, which are seen sliding dramatically in March. When will they recover in a world of falling demand?

Earnings forecasts look optimistic to me in many cases; with the entire U.S. economy shut down, 15-20% unemployment and -20% GDP, earnings are only expected to decline by 10%? Come on; really? Even assuming a 15% decline in GDP (some estimates run as high as 30%), the suggestion of only a 10% decline in earnings seems laughable. We need to stop looking back at 2008 for the global economy did not stop dead in a hurry. There is no precedent for this and any expert that says they can see through this is either long equities or delusional. If anything, oil has shown just how big an issue we may be facing and just how far markets can move. Maybe we need a deep recession so we can reset from this current madness. The fact that cash does not offer an alternative to being invested for a while with any yield is missing the point. This may be a time for a return of capital rather than looking for a return on capital; oil has taught us that and there is no reason why it cannot happen to other markets like equities. I do not understand how all other risk assets can be flashing red and equities keep surging just because the Treasury and the Fed are supplying liquidity. But I guess when given free cash the banks might as well gamble.

It is not only the US bond markets that are facing a Tsunami of issuance hitting the markets, as governments go all-in on spending with money they do not have. Britain will likely sell £270bln of gilts in the fiscal year that started this month, to fund spending plans needed to combat the economic damage from the coronavirus, according to a Bloomberg survey of nine primary dealers. That would top the 2009-2010 high of £228bln and mark an overrun of more than 100 billion pounds from last month’s initial estimate. Ten-year gilt yields were around 0.3% yesterday, after climbing from a record low of 0.08% reached in March. That is staggeringly low but it seems the BoE is committed to monetizing this debt. They may not call it that but that it what they will be doing. The Fed is doing the same and the wave of issuance coming there is simply massive and the rules are being bent to the extreme on what these central banks can legally do. They just call it something else.

It is also suggested that the number of soured U.K. commercial property loans started rising in 2019 for the first time in eight years and this before the crisis. Now, it’s set to skyrocket according to some analysts. The coronavirus outbreak will trigger as much as £10bln of losses and write-offs on loans tied to U.K. stores and malls, according to a survey of lenders by Cass Business School. That’s after a slump in retail property saw the value of bad loans spike by more than a third last year, though to a still relatively low 2.9 billion pounds. This year will be far worse. GBP fell quite hard yesterday as the USD rallied and EURGBP squeezed higher as I thought it might and GBP is facing more uncertainty now that the Brexit talks are back on and time is rapidly running out. Having said that, the EU is still facing its own set of crises.

I was surprised stocks were not lower this morning when I got to my desk after a weak close on Wall St. Nikkei was down 1% but HK and Shanghai little changed. Netflix shares rose after the close of regular trading when the company said it added nearly twice as many subscribers as predicted in the first quarter. Maybe that is why as investors see another push into the top 5 stocks that seem to drive the whole S&P. Chipotle withdrew its earnings guidance. US bonds continue to rise with the 10yr yield now at .055% and the 5yr at 0.33% which are remarkable levels.

Are the jaws in the chart above about to snap shut? The problem with a lot of data is that it is either backward looking or not picking up current issues.

We need to look at something relevant to now. The closest we can get to that in the US is the New York Fed’s Weekly Economic Index (WEI), released yesterday for the week ending April 18. It is based on ten daily and weekly indicators – “timely and relevant high-frequency data,” as it says – of “real economic activity.” These indicators cover consumer behaviour, the labour market and production. The researchers putting the index together have scaled the index “to align with the four-quarter GDP growth rate.” Here it is:

The index has plunged over the past five weeks to -10.95%. If this reading persists for the entire second quarter, then the year-over-year GDP plunge in Q2 is expected to be around -11%. The chart below, which covers 2019 and 2020 so far, shows the plunge in economic activity by week over the past five weeks. Before it all started, the economy wasn’t all that hot, with diminishing growth rates last year and into this year. For the week ending February 29, on the eve of the lockdowns, the WEI was at 1.58%:

Someone needs to show that to the equity bulls. I am recommending a small short here in S&P at 2773 with a view to add higher nearer 2800+. I can see an argument for a test of the recent lower range at 2400. The signals are all there.

Oil is lower yet again (Brent down 12% as I type) and yet equity investors are happy to ignore the stress seen in other assets. If you start to look at the actual supply-demand situation for oil, it’s not so obvious that by the time those contracts expire (June and July), the storage situation around Cushing will be very different than what it is in May. If production does not fall quickly then we may see a lot more stress. Bank stocks across the developed world are struggling badly as curves are flattened by the steamrollers of central bank policies. EU banks have been falling for a while and the last 2 days saw serious drops in the US sector too.

We also saw BTP/Bund spreads start to edge wider as well yesterday and it may be worth keeping an eye on those again today. There is talk that the ECB could/will expand asset purchases that are on course to reach roughly €1.1tn this year. Italy is getting it from all sides and came into this crisis weak and became the epicentre of the virus for a while. Italy has taken an unfathomable hit.

The borrowing costs are rising at a time of huge action from the ECB. Those Italian borrowing costs are rising even as since launching the €750bn programme, the ECB has bought €30bn-€40bn of Italian bonds (about 40 per cent of the total and more than double the amount implied by Italy’s capital contribution). This is telling, especially as Lagarde says those opposed to doing more are coming round. But I suggest this still may not be enough and I am not sure this issue is curable by actions from the ECB as some seem to think they can. By the way, Italy’s credit rating, which sits just two notches above the junk rating that would force many investors to sell its bonds, is set to be reviewed by S&P Global on Friday. Others are doing more and for instance, the Fed has seen its balance sheet expanded by more than $1tn in the last two weeks of March alone.

It is not all gloom out there as anything having to do with working-at-home, including hardware sales, is booming. Everything and anything that is online is booming — as are the sectors that make it all work, including delivery services. But other parts of the economy have essentially collapsed, with near-zero revenues, such as sit-down restaurants, sports & entertainment events, or the entire travel and accommodations industry, including airlines and hotels. We have never been through something like this, so it is impossible to suggest how long the impact lasts and we do not have a vaccine yet! Consumers are still spending money, but they’re spending less, and they’re spending it in different ways. So estimating where GDP will be in an economy that has shifted so suddenly and so dramatically and where activity in many sectors has plunged from one day to the next is going to be tough. But it seems equity investors feel we can recover quickly. That’s a bit like thinking oil futures could never go negative!

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Strategy:

Macro:.

Small short S&P @ 2773 looking to add.

Brought to you by Maurice Pomery, Strategic Alpha Limited.

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