Chronicle of a Death Foretold
Welcome to this week’s post of the Weekly Overview Series.
In this week…
- Coronavirus cases plateauing in Europe with little rebounds. Cases in Italy and Spain seem to have hit peak. In the UK, as Boris Johnson leaves ICU, cases are still rising but not as fast as in the U.S where most of the states are in lockdown.
- US jobless claims hit 6.6 million as Coronavirus devastates the U.S labour market. Expectations were at 5.25 million. In just three weeks, 16.8 million Americans have filed for unemployment claims. The U.S unemployment rate jumps to 12-13% from a historical low of 3.5%.
- The Federal Reserve has approved another $2.3 trillion stimulus package in loans to small and mid-sized businesses, junk bonds, Collateralized Debt Obligations (CDOs) and Mortgage-Backed securities for an unlimited time: “…until we are confident that we are solidly on the road to recovery” in Chairman Jerome Powell words.
- Europe finance ministers agreed yesterday on a €500 billion package of palliative economic measures but left questions on debt burden sharing and Eurobonds unresolved. As said in last week’s post, Eurobonds would only be sensible if Europe shared a unique fiscal policy.
In this post, the focus will be on discussing what the future looks like for equity markets having the S&P500 as an example. In addition, we will discuss oil markets.
FUTURE OF EQUITY MARKETS
In this chart, it is compared the evolution of the S&P500 index in 2008 when the financial crisis became a reality and in 2020, since the Coronavirus outbreak spread in Europe. During bearish periods, markets become very behavioural, at least in the first few weeks. As a result, we see what it is called a stock crash. Investors flee from every asset and correlations between them break. The huge loss of liquidity amplifies every move in the market, volatility spikes. To fill selling orders, the sellers have to accept much lower prices as there are not many buyers willing to take the opposite side.
When the first phase ends (the crash), during a short period of time, a counterintuitive bullish market starts. In this case, fiscal stimulus packages and ultra-loose monetary policy hopes together with a shallower Coronavirus cases curves fostered the current bullish trend. In this illiquid market, buyers willing to buy the dip, i.e willing to take all the upside from the crash and any of the downside, start buying. Momentum investors, that follow trends and take advantage of short-term volatility, also start buying. Price moves quickly as sellers are awaiting a better price to sell.
On Tuesday, as the U.S session closed, there was a reversal movement of around 4% in the S&P500 followed by further selling in the Asia-Pacific session after moving north in the previous days. We have not seen that kind of movement since the financial crisis. That could be a meaningful signal indicating the end of the second phase, the short bullish market.
The third phase is when fundamentals really start driving the bear market. The earnings releases evidence the worsening of the economic situation across industries, being more affected those more leveraged and those relying in infrastructure for their operations, i.e those that have more fixed costs.
A reacceleration of the Coronavirus cases after the lifting of the lockdown is likely to happen. There is a potential risk of the authorities not being able to control the spread again. The consequences could be catastrophic and a restart of Phase 1 (Stock Crash) would be feasible.
JPMorgan summarizes the evolution of the controlled infection curve here:
OPEC+, OIL AND THE END OF THE PRICE WAR
Yesterday, OPEC+ alliance held an emergency meeting to lower global production and stabilize prices, that was encouraged for the first time by the U.S as low prices risked the existence of both small U.S shale companies and huge such as ExxonMobil. The OPEC+ agreed to a 10 million barrels supply cut in May and June, shrinking to 8 million from July and then 6 million from January 2021 to April 2022. The refusal by Mexico to cut the production by 400,000 barrels as they are willing to go ahead with their planned spending could endanger the deal.
The U.S cannot participate in this deal due to anti-trust laws. Russia insisted that the U.S has to do more than letting the market forces reduce the production. Trump, replied the cut will happen automatically as shale producers are in serious difficulties.
In today’s G20 energy ministers meeting, countries such as U.S and Canada are expected to contribute with 5 million barrels to the global reduction.
The oil prices dropped 7% to $23/bbl as the potential deal did not meet expectations of a 10 million or more cut for three months at least. Furthermore, the compliance of members participating is not assured.
Below, it is depicted January 2020 oil supply and the OPEC’s deal compliance by country, differentiating between countries whose cutbacks reached target and those that did not.
While a 10% cut in global supply is a historical record, it does not offset the demand loss, estimated in 35 million barrels a day. Lockdown extensions could deepen this demand losses in the U.S, India or Europe. There is a real risk of having to shut down production as inventories pile up. The most important oil storage in the U.S, in Oklahoma, is running out of space.
China could provide a glimmer of hope to the global oil market as its refineries (“teapots”) are now running at an all-time high.
Oil prices prospects are bearish, further to the downside. They could perfectly be in the under $20s area, heading to 9/11 historical lows, set at around $17 per barrel.
This time, to finish, I leave here the S&P500 weekly performance map as per normal and a Coronavirus evolution curve by country: