Month: March 2020

In a stunning miss to expectations, March’s Dallas Fed Manufacturing Outlook survey crashed like never before (from +1.2 in February to -70.0 – massively below the -10.0 expectation).

Source: Bloomberg

As you can see, this is the weakest level ever and the most aggressive collapse ever. As one trader mocked when the data hit, “…is that a bad print?”

The measures production and new orders both were lowest since 2009.

The figures are consistent with severe declines in other regional gauges as unprecedented shutdowns freeze large parts of the industrial economy. Regional Fed bank measures of manufacturing in New York, the Philadelphia area, and Kansas City district all showed record monthly declines.

Source: Bloomberg

Of course, Texas has been hit with both barrels of collapse as the oil price war and national virus lockdown crush markets.

Authored by Bill Blain via MorningPorridge.com,

“Damn, he was good. Came out of nowhere. Hit us with a full broadside, cut across our tail and took out our rudder. Damn fine gunnery.”

According to the press, China is experiencing normal traffic jams, while the major threat is reinfection from the West, so borders are locked shut. They are anticipating business as usual. They are in for a shock. 

JP Morgan are on the wires saying markets have made their lows, and although it will be volatile, its time to “average into oversold markets.”

In my opinion… they are fools. 

I suspect this is going to be a very very bad week for markets. 

April is going to hurt. Last week’s rumbustious rally on the back of kitchen sink government fiscal promises, QE infinity and “the boys will be home by Chistmas” market optimisim, is going to be crushed. The flow is about to get much worse, in a trifecta of economic, business and virus news. 

We are about to learn a sharp brutal lesson about expectations versus reality:

• There is no swift end in sight. The UK has been warned to expect months of distancing. Trump isn’t reopening the economy for Easter – he’s closing America down till May.

• Oil prices have crashed below $20. 

• Rising economic damage, business failures, and confirmation of massive unemployment – especially in US – will come to fore in this week’s data and numbers through the month. Government support packages will take months to become established – months the markets don’t have.

• Aside from a few ultra-high Investment grade cash-rich corporates, there is a massive industrial scramble for cash underway. Anyone able to raise cash should lift any offer – before a slew of downgrades and defaults closes credit markets completely. 

• Emerging Market economies were pummelled by dollar strength, are now about to be devasted by the global virus demand shock, and as virus countermeasures hits already unstable nations could well plunge into chaos. 

• Market chartists will tell you optimistic bear rallies are a standard part of every market crash – and the bottom will be retested a number of times. 

• There is still pain to come. There are a large number of investors – both institutional want-to-be’s (like JP Morgan) who buy the stimulus and are thinking there are easy returns to be made after such a large “correction”, and retail buyers who are fearful their retirement savings have been shattered who are willing to shake the dice. They can’t quite believe what’s happened, don’t compute the scale of the economic shock, and won’t face up to a changed world till they take more pain.

If any of these are positive reasons to sustain last week’s rally, feel free to explain in the comments section of the Morning Porridge below. 

A number of good analysts suggest the chances of a swift recovery are better than the bleak headlines suggest. They quote issues like obvious market opportunities will swiftly attract smart money – which is true, and the natural resilience of capitalist economies in the face of economic catastrophe – which was once true. 

I hope they are right, but I wonder about human economic behaviour – which tends not to have read Rational Expectations economic text-books. What tends to happen is at the individual agent level, where they seek to maximise personal gain by arbitraging distortions like government bailouts and free money in unexpected ways. 

Not every entrepreneur will use a government guaranteed loan to tide over their business – some may use them to wreck the competition, enrich themselves, invest in risk, or act in a thousand other ways. Market distortions and interventions have unintended consequences which ultimately prove negative – a lesson governements and central banks have been trying to ignore for the last decade of monetary distortion and experimentation. 

(If you don’t believe me, explain why thousands of corporates spent the last decade buying back their stock instead of investing in new productive capacity and new product innovation?)

Get ready for a long-haul of increasingly dire economic news. A month – at least – of Lockdown helplessness, as corporates and individuals scramble for cash, struggle to obtain funds and face unmeetable demands for rent, mortgages, and to pay off debts. It’s going to be brutal. 

Is there any good news? 

Perhaps in the virus itself – but this isn’t about the Wuhan flu. It’s about the economy. In the absence of real data in many countries due to the lack of testing, we’re forced to make guesses. But the trends are showing infections rise (as testing kicks in) and a falling mortality percentage. The pace of mortality deaths is declining – as was expected to happen as lockdowns lower the R transmission rate and the all-important “critical cases in hospital” curves. We will find out how successful its’ been in coming days. 

On the other hand, the first obituaries of coronavirus victims are appearing; including a number of fit, middle aged men, demonstrating the random nature in terms of victims and symptoms. 

To tell a story: after struggling with the disease for over a week, a fit chap in his late fifties I know in London ended up in Hospital, (and fortunately got better quickly once given oxygen and sent home). Meanwhile his partner and her daughter are showing zero symptoms and feel absolutely fine (although badly traumatised by his illness), despite all being cooped up together in a London flat.

The virus storm will likely escalate across North-West Europe and the US this week, while plateaus across Italy and Spain are expected. Will Europe reopen as quickly as China – unlikely because there has been less testing, less source tracing and very little real information to base decisions upon. 

Don’t be fooled – as markets were last week – that there is an easy and quick answer to this crisis. However, there are definitely investment opportunities out there. The trick is grabbing them and holding on through the coming storm..

Over the weekend, we reported that with the oil industry oversupplied by a mindblowing 20 million barrels daily as roughly 20% of total global output ends up unused in a world economy that has ground to a halt, and instead has to be parked in storage either on land or sea, the unthinkable is about to happen: oil storage space is about to run out, and as that happens the price of oil will continue sliding ever lower and lower until it finally goes negative as some such as Mizuho’s Paul Sankey predict it will, over the next few months, leading to an unprecedented shockwave across the global energy market.

Then overnight, more eulogies for the oil market emerged, with Bank of America writing that oil has now slumped “into the abyss” and it expects to see the “steepest decline in global oil consumption ever recorded, with our base case reflecting a 12mn b/d drop in 2Q20 and a 4.5mn b/d contraction on average for the year” and on a net basis, BofA now expects global oil demand to contract by almost 17mn b/d in April with consumption recovering modestly into 3Q20 and beyond.

The bank also adjusted its oil price forecasts for 2020 and 2021 down to $37 and $45/bbl for Brent and to $32 and $42/bbl for WTI respectively, but in the near-term, it sees both benchmarks temporarily trading in the teens in the coming weeks.

However, by going all “there will be blood” on oil, BofA has only caught up where Goldman has been for the past two weeks, ever since it predicted that the “physical end was near.” Meanwhile, in a note of unprecedented gloom, Goldman now says that “the physical end is here” as the coronacrisis goes global.

As Goldman’s Jeffrey Currie calculates, the oil surplus generated by an unprecedented demand shock has begun to hit physical constraints at refineries, pipelines and storage facilities, “leading to at least 0.9 million b/d of announced shut-ins at the wellhead, with the true number likely higher and growing by the hour.”

With social distancing measures now impacting 92% of global GDP, the ultimate magnitude of these shut-ins which is still unknown will likely permanently alter the energy industry and its geopolitics, restrict demand as economic activity normalizes and shift the debate around climate change.

In other words, what is taking place now is “not only is this the largest economic shock of our lifetimes” but from a practical perspective, “carbon-based industries like oil sit in the cross-hairs as they have historically served as the cornerstone of social interactions and globalization, the prevention of which are the main defense against the virus.”

Accordingly, oil has been disproportionately hit, likely more than 2x economic activity, with demand this week down an estimated 26 million b/d or c.25%.

As a result, and picking up on what we said over the weekend, Goldman now warns that “this shock is extremely negative for oil prices and is sending landlocked crude prices into negative territory.” Of course, it is only a matter of time before this ultimately creates an inflationary oil supply shock of historic proportions because so much oil production will be forced to be shut-in, but first we need to see prices close to zero… or below it.

Currie next focuses on the storage conundrum we discussed yesterday, and how – as we warned – this will lead to negative oil prices:

The global economy is a complex physical system with physical frictions, and energy sits near the top of that complexity. It is impossible to shut down that much demand without large and persistent ramifications to supply. The one thing that separates energy from other commodities is that it must be contained within its production infrastructure, which for oil includes pipelines, ships, terminals, storage facilities, refineries, and distribution networks. All of which have relatively small and limited spare capacity. We estimate that the world has around a billion barrels of spare storage capacity, but much of that will never be accessed as the velocity of the current shock will breach crude transportation networks first, which we are already seeing evidence of around the world. Indeed, given the cost of shutting down a well, a producer would be willing to pay someone to dispose of a barrel, implying negative pricing in landlocked areas.

The good news, however, is that from the devastation that will follow in the coming months, a new – and far more viable – industry will emerge, or as Currie puts it “the current oil crisis will see the energy industry finally achieve the restructuring it so badly needs. We have long argued that it is the supply and demand of capital that matters, not the supply and demand of barrels; as long as there is capital, companies can withstand difficult periods and the barrels always come back.”

The rest of his full note is below:

Waterborne crudes like Brent will be far more insulated, staying near cash costs of $20/bbl with temporary spikes below. Brent is priced on an island in the North Sea, 500 meters from the water, where tanker storage is accessible. In contrast, WTI is landlocked and 500 miles from the water. This illustrates an important point. Shut-ins will be not be based upon where wells sit on the cost curve but rather on logistics and access. High-cost waterborne crude oil that can reach a ship (storage we have historically never ran out of), are better positioned than landlocked pipeline crude oil sitting behind thousands of miles of pipe, like the crude oils in the US, Russia and Canada. In 1998, when surpluses last breached storage capacity, it was these landlocked crude oils that were the hardest hit. So while markets like WTI, particularly WTI Midland, or Canada’s WCS can go negative, Brent is likely to stay near cash costs of $20/bbl. Ultimately, the market never hits nameplate capacity, as other bottlenecks are also at play. During 2008 and also in this crisis, dollar funding and credit constraints that prevent oil owners from accessing storage and transportation capacity also played a role. We believe that the Fed’s actions last week alleviate some of this risk, but oil itself creates dollar liquidity given its importance in global trade and setting the price of other traded goods and another sharp drop in oil prices could create additional dollar shortages.

The oil price war is made irrelevant by the large decline in demand and has made a coordinated supply response impossible to achieve in time. A month ago, the logic of the price war made sense when the demand shock was c.5.0 million b/d. It gave OPEC and Russia the first opportunity since 2012 to completely undercut shale, and finally reverse the production cut in 2016 which we believe never made economic sense to begin with. Not only did OPEC producers sacrifice $220 billion in lost revenues (annually at $60/bbl Brent) and market share, but so did the equity and debt shareholders of higher-cost producers. The artificially higher prices distorted incentives for oil investment, leading to inefficient capital spending by these companies that, by our estimates, destroyed roughly $1.0 trillion worth of market cap since 2016. The policy of production cuts was a strategic error, not only to OPEC+ countries, but to all equity and debt owners in the industry. Now the question is: can the US and OPEC save this market? The demand shock has become so large that they can’t do it alone, a fact they have acknowledged, stating that a balanced market would require a coordinated global production cut — a policy which appears impossible at this point, too late to stop the current surplus and far below other initiatives on the agenda right now.

The key to how quickly prices rebound after this supply shut-in will depend on how much inventory is built. Markets are already hitting transportation bottlenecks without having filled storage capacity. Oil in Canada is now near $5/bbl and WTI Midland $13/bbl with Cushing inventories still only half full. The quicker and harder these capacity constraints are reached, the quicker and more violently the market will rebalance when production shuts in, and the quicker deficits return to the market, putting upward pressure on prices. In the bear market of 2015/16 production shut-ins were based upon a producer position on the supply cost-curve. Unlike then, the logistical nature of the shut-ins suggest they will be completely indiscriminate, inflicting substantial damage on the wells that in some cases will be permanent. Once economic activity begins to normalize, the deficits will likely be substantial as the rebound in demand will be constrained by supply that has been damaged by the shut-ins. This could potentially require continued destruction of commuting and jet fuel demand. Net, if pipelines get clogged up as refineries shutdown, inventories cannot build, reducing the cushion and creating a very quick risk reversal towards oil shortages that could push prices far above our $55/bbl target for next year.

This will likely be a game-changer for the industry. Once you damage the capital stock in oil it is an expensive and time-consuming process to rebuild, assuming it can be rebuilt at all. This contrasts with the rest of the economy where the capital stock is sitting idle and ready to restart, which is why it is expected to exhibit a V-shaped recovery. In contrast, we believe the upstream sector could lose as much as 5.0 million b/d of oil supply capacity. With that much supply loss the industry will unlikely be able to rebound even close to old demand levels without creating substantial price appreciation, the scale of which will be determined by how much inventory is built in the coming weeks. In addition, the geopolitical landscape is also changing. We note the current political situation in Venezuela, where further US sanctions have been imposed for over half a year and where Rosneft divestitures of oil assets occurred over the weekend. At the same time, Iran has been heavily impacted by the coronavirus, which follows the rise in tensions between the US and Iran in January, during which oil reached its recent peak of $70/bbl. On top of this, there could be further geopolitical instability generated by the extreme economic conditions forced upon the many oil producers in Africa and Latin America.

Oil and gas fields are far different from other manufacturing processes. They are organic deposits and as such have decline rates, having shut an older well it may not be economic to bring it back online. Most of these older, more depleted and less productive wells are onshore, not offshore, which makes them the most vulnerable to shut-ins. We believe shut-in economics will be driven by three factors: 1) crude net-backs (driven by local infrastructure constraints and crude quality); 2) variable cash costs (highest in mature fields with low flow rates); 3) decommissioning liabilities (most material for offshore deep-water fields). As such, we believe that shut-ins are most likely at onshore, mature, depleted, heavier and sourer oil reservoirs in countries like Canada, the US, Russia, Latin America and China. Offshore fields are least likely to be affected, due to their generally higher crude quality, lack of infrastructure constraints and high decommissioning liabilities. Mature, heavier oil, high water-cut reservoirs will also suffer the most from a prolonged shut-in and may not return to their pre-shut-in production capacity once oil demand increases.

We believe the current oil crisis will see the energy industry finally achieve the restructuring it so badly needs. We have long argued that it is the supply and demand of capital that matters, not the supply and demand of barrels; as long as there is capital, companies can withstand difficult periods and the barrels always come back. The difference between today and 2015/16 is that shale and high-cost oil producers were already facing sharply higher costs of capital over the past year due to persistently poor shareholder returns. Indeed, these capital restrictions have only been exacerbated by recent events, whereas in 2015/16 capital never dried up – making the likelihood of capitulation by US E&Ps and EM producers much higher today. Further, the rebalancing phase in our New Oil Order framework was cut short in 2016 by Chinese stimulus that boosted demand followed by OPEC+ production cuts that curtailed supply. In the end, we never saw the final regeneration phase of rationalized assets that would have created a more sustainable industry over the longer term.

Today, we have already seen uneconomic firms shut off from capital. This suggests that the overdue rationalization of the industry is finally set to occur. We believe it will be very selective with a clear focus on upgrading portfolios: Big Oils will consolidate the best assets in the industry and will shed the worst assets. There will be local consolidation amongst E&Ps, and when the industry emerges from this downturn, there will be fewer companies of higher asset quality, but the capital constraints will remain. Capital markets focused on de-carbonisation and lack of visibility over long-term demand will constrain the remaining firms, leading to structural underinvestment and higher corporate returns, bringing an end to energy’s lost decade. Only a significant supply shortfall once demand recovers could slow this much-needed industry consolidation and rationalization. A large, sustained deficit would lead to much higher prices until even marginal shale producers respond, as they remain the fastest cycle source of supply.

The climate change debate will almost certainly take a different course when the global economy emerges from this and is faced with the prospect of having to make large-scale investments into carbon-based industries. The silver lining of the coronacrisis is that the virtual shutdown of key carbon industries – autos, airlines and cruise ships –
is likely to cause carbon emissions to fall this year, with initial data from China pointing to a c.20%+ fall during the peak of the shutdown. It is important to emphasize how the current shock is hurting the unsustainable industries but encouraging sustainable industries. The aircraft and migrant workers that used to bring the world fresh fish, fruit and vegetables have been stopped.

Technological hysteresis is already occurring. People are adapting to a more local existence and living off more sustainable activities, consuming less globally-produced fresh food, producing less waste with a more conservative approach to consumption, all of which may have lasting impacts on demand. Further, commuters and airlines account for c.16.0 million b/d of global oil demand and may never return to their prior levels. While oil prices are low today and physical constraints are forcing the behavioral changes, as oil shortages develop once economic activity normalizes, the high oil prices will likely accelerate the energy transition by constraining demand. For example, commuting and jet demand destruction may still be needed to cope with the supply shortage that is likely to occur once significant supply capacity is hampered. Higher oil prices would also greatly improve the relative economics of EVs and hydrogen. But from the supply side, capital markets’ push for de-carbonization is likely to prevent the broad investment the industry will need to get out of this crisis and will reinforce a tight physical market beyond 2020.

Low returns in energy and commodities have been referred to as a lost decade. Oil has handed investors losses of about 8% per year since 2010. However, we believe that a bottom will be carved out in the coming weeks or months that will serve as the foundation for solid future returns similar to 1999. Combining these potential supply constraints with the large fiscal stimulus in response to the virus, we believe that physical inflationary concerns – with the dollar starting near an all-time high – will finally dominate the financial asset inflation that was a feature of the past decade that acted as a drag on energy and commodity returns. In the very near-term, however, we would play it from the short side. Nonetheless, we must keep in mind the fact that each downturn has become increasingly shorter in duration as the system has been able to adapt more quickly, and although oil prices are likely to further decline in the coming weeks, it is important to start focusing on the transition.

Once again, pending home sales will be the tie-breaker for February housing data (existing sales soared, new sales slipped) and expectations were that it would be weaker (after a huge surge in January) but instead it surged 2.4% MoM (vs 1.8% drop expected).

January’s upwardly revised (from 5.2% to +5.3%) spike was the highest since Oct 2010 and the YoY rise in sales of 11.5% is the highest since April 2015

Source: Bloomberg

This is the highest level (SAAR) of pending home sales since April 2016…

Source: Bloomberg

Pending sales last month increased in all four regions, led by a 4.6% gain in the West and a 4.5% advance in the Midwest. The index for the South, the largest region, was the highest since March 2006.

“Housing, just like most other industries, suffered from the coronavirus crisis, but once this predicament is behind us and the habit of social distancing is respected, I’m encouraged there will be continued home transactions though with more virtual tours, electronic signatures, and external home appraisals,” Lawrence Yun, NAR’s chief economist, said in a statement.

Yun noted that the data do not capture the fallout from measures taken to control the outbreak.

So the question is – have homebuilder stocks over-reacted or are we just not seeing the impact of COVID-19 lockdowns in the data yet?

Source: Bloomberg

We suspect we know which.

President Trump gave a wide-ranging interview on Monday on Fox & Friends, where he covered everything from coronavirus and the current situation in New York, to the Green New Deal, to Nancy Pelosi.

Trump said he thinks New York will be “fine” and that they won’t need all the ventilators they’ve requested, adding “After this is over they’ll be selling them for a dollar a piece.“

Trump predicts that “New York should be fine … they should have more than enough” ventilators “based on the numbers that we see,” claiming without evidence that the state is sitting on thousands of unused ventilators. pic.twitter.com/Rqf9Db89lZ

— Bobby Lewis (@revrrlewis) March 30, 2020

He also said that the virus will ‘spike’ (peak?) around Easter, and that deaths “will be at a very low number.” There have been 2,500 deaths in the US as of Sunday night – up from 2,000 on Saturday and 1,000 last Thursday.

When asked a question from a nurse who wants to know about hazard pay for front-line responders, Trump said “We are looking at that … either as an amendment or something.”

When host Brian Kilmeade tells Trump that “Russia, Iran and China” are conspiring to blame the United States for spreading coronavirus “using the same principles they used to infiltrate our 2016 election,” Trump replied that the story was fake because it was in the Washington Post.

Brian Kilmeade tells Trump that “Russia, Iran, and China” are conspiring to blame the US for coronavirus “using the same principles they used to infiltrate our 2016 election.” Trump replies that the whole story is fake because it was in The Washington Post. pic.twitter.com/jaZr6nfbtl

— Bobby Lewis (@revrrlewis) March 30, 2020

After saying that 2.2 million people could have died, before calling Nancy Pelosi a “sick puppy” for criticizing his response to COVID-19, calling her comments “a disgrace to her country [and] her family, and adding that he saved America from “deaths like you have never seen before.”

Trump calls Nancy Pelosi “a sick puppy” for criticizing his pandemic response, and claims that he saved America from “deaths like you have never seen before.” He also calls Pelosi’s comments “a disgrace to her country [and] her family.” pic.twitter.com/dF31aQDksD

— Bobby Lewis (@revrrlewis) March 30, 2020

Trump also blamed the media for “building wars” between he and governors, saying they actually get along well. 

Watch: In exclusive Fox & Friends interview, President Trump blames the media for “building wars between” him and governors, saying they get along well. pic.twitter.com/nHMsE0tPKm

— TV News HQ (@TVNewsHQ) March 30, 2020

More:

Trump says truck drivers should be fine if they’re alone in their cab all day. He adds, “I know a lot about trucks.”

— Daniel Dale (@ddale8) March 30, 2020

Trump says he’s talking to Vladimir Putin after Fox & Friends. He mocks his opponents’ previous “Russia, Russia, Russia” focus. “We have problems with other countries. More than Russia, frankly.”

— Daniel Dale (@ddale8) March 30, 2020