Beneath The Surface
We had another mixed week in the stock markets with the now-familiar negative sentiment persisting throughout. Global financial markets seem to have entered a somewhat stable pattern now as stock markets drift broadly sideways, without recording meaningful gains or losses at the index level.
Barring any new earth-shattering disasters coming along (and we're not sure how much more the world can handle at this point), we think that at the index level (S&P500, FTSE100, DAX, etc.), stock markets are likely to continue trading rangebound over coming weeks. While we are likely to continue seeing large adjustments at the industry (see below) and single stock level - it feels unlikely we will see the types of 5%+ weekly moves we've seen over the past couple of months.
This is because we've had a period of indiscriminate selling from Feb 21 - March 23 reflecting acute uncertainty about what the rest of 2020 will look like. Over the second half of March, governments around the world moved to enforce lockdowns, helping the world paint a (slightly) clearer picture of what the future will look like. At this point, it started becoming increasingly apparent that certain parts of the economy - mainly the digital economy and some stay-at-home winners - should come out of this relatively unscathed. This prompted a furious bear market rally led by these digital economy and stay-at-home stocks.
Today, the relatively obvious winners and losers now trade at share prices which reflect this optimistic (Amazon, Netflix) and pessimistic (Delta, Southwest) reality, and deciding which remaining industries and companies will do well becomes slightly more nuanced. To bring this point to life, let's have a quick look at two industries:
You may have seen US crude oil futures contracts having briefly traded in negative territory this week - a historic first. We won't go into the technical reasons behind why this happened here, but it's obvious that this isn't great for those companies who produce oil (and employ millions of workers in the process).
There's a simple demand / supply imbalance at play here - largely thanks to hundreds of millions of people now unable to drive or fly, global oil demand has dropped by around 30 million barrels per day during this pandemic whereas the OPEC supply has been cut by less than 10 million barrels per day. With excess supply, we soon run out of places to put the stuff and see the resulting collapse in prices that you'll have seen all over the headlines this week.
Each oil producer has a varying break-even oil price - the dollar value of a barrel of oil at which they can continue producing profitably - for many US producers this break-even is around $30 per barrel - well north of the $10-$20 range which US WTI oil prices have been trading in. When you take into consideration that the US is now the world's largest producer of oil (thank you, Donald Trump(!)) - this is clearly not great for the industry as a whole.
Somewhat counterintuitively, the S&P500 oil & gas sector this week was actually the strongest performer, gaining more than 10%. But this reflects the fact that this time last week, the outlook was for oil prices to stay below $10 per barrel. Clearly it's positive for the sector that oil prices have rebounded somewhat to trade closer $20 per barrel, but if this situation persists for an extended period of time, we wouldn't be surprised to see bankruptcies ballooning in the US oil & gas space throughout the rest of this year at the very least.
The global auto industry is likely to be another casualty coming out of this, and not just because we aren't using cars at the moment.
Since 2008, the world has increasingly adopted the car leasing model, with strong growth in the number of consumers who choose to finance their cars versus buying outright. These consumers may soon be forced to default on their car loans, resulting in losses for the automotive manufacturers who have financing arms which have been dishing out these loans.
Automakers have been pointing to the fact that the industry as a whole is much more resilient today than it was in 2008. This is no doubt helpful, but the nature of the industry is cyclical and likely to be acutely painful at a time like this.
This is because car manufacturers have high fixed costs - factories cost a lot of money even if they're not producing cars. Especially when they're not producing any cars. When they're shut, car makers burn a lot of money, fast. To put some numbers on this, the top 8 European car manufacturers are likely to burn through $50bn of cash this quarter, with no sales to offset these costs. At this rate, they may run out of money by the end of 2020. Hopefully this shouldn't be the case provided we can get back to something which resembles a normal world in the second half of this year.
Elsewhere, all is not lost - those with strong cash positions, strong balance sheets and comparatively lower fixed costs with other revenue streams (read: Tesla) should be okay.
The Macro Perspective
Plenty of reasons to be cautious as an investor, then.
But on the flip-side, there are also some reasons to be optimistic. We continue seeing western governments throwing money at the problem - this should eventually help stabilise industries.
The latest notable bout came out of the US yesterday, with news of a new $480 billion relief plan in addition to the $2.2 trillion CARES act that has already been signed off in congress. This relief plan will mostly go to small businesses as the US looks at possible extension of the lockdown into the summer.
Furthermore, we expect more out of the European Union next week. The bloc agreed on Thursday to revamp the EU's long term budget, part of which includes a new - likely sizeable - fund to combat the economic grim reaper that is COVID-19. Financial markets expect an additional €1-1.5 trillion will be needed here on top of the €500 billion already being deployed. The size of this European fiscal response is likely to drive European stock markets at the index level next week.
Elsewhere and unsurprisingly, we continued seeing economic datapoints waving the proverbial red flag this week - here's the latest:
Germany's composite PMI reading - a barometer of manufacturing and services activity in Europe's largest economy - fell to an all-time low this week. The 17.1 reading was well below both the previous reading of 35.0 and expectations of 31.0. This is consistent with the European Central Bank's warning of the Eurozone economy experiencing up to 15% reduction in GDP for 2020.
US jobless claims continued their dismal run. This week saw another 4.43 million Americans registering as jobless, taking the the total so far north of 26 million. The US monthly unemployment report is scheduled for release on May 8th - as always, we'll be watching.
Finally, just in case it wasn't already clear that we are living in uncertain times
By some estimates, around 25% of European companies have so far given up trying to predict or giving guidance on their outlook for 2020 as part of their earnings releases with almost 200 so far having cancelled or postponed their dividends.
Until next week, we hope you stay safe and manage to enjoy the socially-distanced sunshine which Spring is bringing with it 🌤
Please know, the value of investments can go up as well as down and you may receive back less than your original investment, meaning, when investing your capital is at risk.
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