Friday, 24th of April 2020
“There are decades where nothing happens; and there are weeks where decades happen.”
– Vladimir Lenin
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Markets have plateaued this week after experiencing a strong recovery since mid-March. The S&P 500 Index was down -2.7% by Thursday close, and is flat so far on Friday morning. Both the STOXX 600 and the MSCI EM Index are also negative for the week as the shift in sentiment reaches beyond the US. It now seems clear that some of the momentum behind the liquidity-driven rally has been lost as investors reassess fundamentals at current levels and given the depth of economic harm that has become unavoidable this year. Many of the large price dislocations that characterised markets during the unprecedented sell-off last month (e.g., in IG credit, where we took advantage of the wides to add exposure) have disappeared (although not in oil markets) thanks to the huge fiscal and monetary stimulus pledged by governments and central banks around the world. The dominance of speculators and widespread panic among investors has infected markets for the past six weeks and was responsible for a precipitous v-shaped correction in asset prices. However, that has now given way to pervasive insecurity about the correct level of asset prices and a general sense of foreboding. Questions abound. What is the right price for Airbus shares? Is a bond issued by a cash-flushed E&P company worthless or money-good? Will banks be forced to cut their dividends? Where the hell is Kim Jung Un? However, satisfactory answers are hard to come by. With the possible exception of the answer to the last question, they are all a function of the duration and intensity of the coronavirus crisis, which are unknown variables at this time. Uncertainty may not be something from which investors can ever hope to escape, but it is rightly the overriding concern today. As such, we are happy to keep our equity hedges in place even as countries mull how to lift lockdowns that they imposed to control the virus.
Beyond the ongoing uncertainty over covid-19, the interplay between two countervailing forces will drive price action this summer; namely, macroeconomic stimulus and microeconomic reality. The former is positive for markets but cannot sustain them alone, or indefinitely. Ugly fundamentals will always fight back eventually, at which point (to paraphrase JFK) those who sought returns by riding the tiger end up inside. So far this year, there has been a barrage of macroeconomic data and information about the monetary and fiscal response to the pandemic. For example, we learnt this week that the US will make another $484bn available in loans to struggling small businesses, while 4.4m Americans signed up for unemployment benefit for the first time last week. Meanwhile, flash April composite PMIs for the US and the Eurozone have sunk to a record 27.4 and 13.5, respectively (Note that >50 signals positive growth). Nevertheless, there has been a dearth of company-specific data, and the microeconomic impact of the pandemic has, in large part, been inferred from anecdotal evidence. That is beginning to change as corporates report their Q1 earnings and update (or withdraw) guidance for 2020. The results look mixed at best.
Among hard hit sectors, airlines continue to stand out. For example, Delta Airlines reported a $534m first quarter loss on Wednesday, warned that revenue was likely to fall by 90% in Q2, and suggested that demand for travel was not likely to return to its pre-2020 levels for many years to come. On the same day, Virgin Australia announced that it was going into administration in advance of a restructuring. Beyond airlines, however, a diverse range of companies across industries warned of large top-line and bottom-line declines in the months ahead. For example, IBM cut its guidance amid concerns about the roll out of cloud computing in the circumstances, Coca Cola announced that global sales had fallen by -25% in April with major ramifications for its 2020 earnings, and Lockheed Martin pulled its full-year guidance altogether. In Europe, the German software company SAP failed to meet expectations for its Q1 earnings and revenues and warned that demand for licenses was likely to collapse, while Peugeot reported a -16% fall in Q1 revenues and guided for a -25% decline in total vehicle sales across Europe this year. Meanwhile, Heineken was forced to cancel its dividend as Q1 sales volumes fell -14% and earnings tanked -69%.
Nevertheless, some companies reported much better-than-expected Q1 results and saw subsequent price appreciation. For example, the US fast food chain Chipotle announced that its online sales were up 80% in Q1 and bounced on the news, while German company Sartorius, which makes laboratory equipment, actually raised its revenue forecast for the year! Dispersion among sectors and companies is likely to drive many rotations within market indices this year. In such an environment, active management can offer significant benefits (even with the liquidity pumps at full blast).
The most extraordinary event took place in oil markets on Tuesday this week – the near-term futures contract on West Texas Intermediate (WTI) fell into negative territory for the first time in history, reaching -$37.63 at one point. The single-day move was very large, with WTI opening at $17.85. Oil demand is cratering amid the coronavirus outbreak, and the benchmark US oil price had been on a downward trend since the OPEC+ countries announced a massive but ultimately insufficient production cut on the 12th of April. However, what drove the price dislocation this week was the forced selling of May futures contracts ahead of the Tuesday expiry by speculators who had no wish (nor ability) to take physical delivery of the barrels that they would own at the close. Normally, price action around the expiry of oil futures is fairly contained with those who want to roll their positions doing so with little impact on the spot price of oil. However, reports that storage facilities in Cushing Oklahoma were full meant that many oil traders were reluctant to buy additional barrels of oil from those who wanted to sell them. The speculators became so desperate to offload the May futures contracts that they were happy to pay for the privilege, and the price of oil went sharply negative. The price moves in the near-term contract had an impact on futures further along the curve (and also on Brent Crude which was down sharply for the day). Since Wednesday, however, the oil price has rebounded quite a bit, with the front month (i.e., June) rising back to ~$17. Looking forward to mid-May, similar events around the expiry of the June contract cannot be ruled out if lockdowns last longer than expected. Nevertheless, oil is now so cheap that for those who can store it, buying the stuff looks likely to be very profitable indeed. Time to clear out the garage.
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