29 June 2020
Investors don’t ask many questions when markets are in their ‘Excitement‘ phase. And it’s too late to ask when they move into ‘Convulsion’ mode, and major darlings of the high-flying years start to go bankrupt.
We focus on Brent as the global benchmark.
The market closed Friday down $1/bbl at $41.03, failing once again to move beyond its June 22 peak of $43.96/bbl. As Reuters notes:
“Brent futures prices have risen by more than 80% over the last two months, the fastest increase at any point for more than a quarter of a century, as the market has rebounded from its worst crisis in decades.”
It therefore seems increasingly likely that the market is now moving beyond the recovery and peak phases shown in the chart, towards breakdown and slump. H1 saw a complete cycle more or less completed, and so it would be no surprise if markets continue to accelerate.
It is also now clear that Q2’s buying binge was due to stock-building rather than a return of demand:
- India filled its strategic reserve to capacity, saving itself $660m (5000 crore)
- China went even further, importing a record 11.3mbd in May, and buying even higher volumes for June/July. Shipping data showed over 50 vessels waiting to offload at Shandong’s oil hub on 18 June, more than double the usual number
And, of course, non-OPEC+ producers are raising output again, with prices at $40/bbl. Last week’s Dallas Fed survey showed more than a third of US shale producers were restarting production by the end of June, and a further 20% would be restarting in July.
Unless demand suddenly recovers, prices will come under increasing pressure in coming weeks.
We focus on the US S&P 500 Index as the world’s major stock market index.
The market just managed to cling on the the 3000 level last week, closing down 88 points at 3009.
But as the chart confirms, it looks as though prices are set to weaken again. They soared upwards after bottoming at 2190 on March 23, as traders assumed the combination of Federal Reserve support and the waves of buying from millions of Robinhood investors would lead to a V-shaped recovery.
But Wirecard’s major bankruptcy last week, as we discuss below, may well be a signal that – as in 2000 with Enron and WorldCom – markets may now discover that some of their high-flying stocks have feet of clay.
We focus on the US 10-year rate, as this is the “risk-free” benchmark for global markets.
Interest rates are also weakening as hopes of a V-shaped recovery fade, as the chart confirms. The 10-year rate tried yet again to rally higher, but closed the week down by 0.06% at 0.63% – giving up all its gains since 14 May.
Having tried and failed to return to its pre-crisis level of 1.29%, it would be no surprise if traders now explore the potential for taking rates lower again, as they refocus on the potential for deflation.
Since the start of the crisis, central banks have assumed that liquidity is the same as solvency. But, of course, it isn’t:
- Liquidity measures the amount of cash that a business has to pay its bills
- Solvency measures whether it is actually making a profit on what it is doing
“Over past few years, stock markets generally increased (albeit on choppy path) with profit margin estimates… at present, along with earnings, margins are expected to collapse while stocks have gone other way”.
Equally worrying, as the second chart shows, is that around 1/5th of US firms are effectively zombies – unable to even pay debt servicing costs out of profits. And many large companies with >500 employees have already gone bankrupt, as Forbes list.
Last week, Germany began to worry about solvency for the first time. One of its top 30 companies, the Softbank-backed fintech company Wirecard “suddenly” revealed that $2bn was missing was from its accounts. And its market value crashed from €13bn to just €500m as its CEO was arrested.
And the IMF headed it’s latest Report, ‘Financial Conditions Have Eased, but Insolvencies Loom Large‘.
As investor Warren Buffett noted long ago, “You only discover who’s been swimming naked when the tide goes out“.