Mar 9 2020 - We Are Bottoming: Forget Oil, Your Shopping List Should Be


I'm seeing peak pandemic, uncertainty, fear, talk of bankruptcy, and oil crashing, which says bottom to me.

The market has spent the last few weeks discounting the worst assumptions. The fall today and maybe the next day or two is a swing too wide toward recession.

There will be no recession. We have seen this movie before, just a year ago, and it was all talk ginned up by the media and political operatives.

It's time to go back to watching the VIX. It's at an unsustainable level going all the way back to the financial crises. This is not the financial crises.

If you are contemplating wading back into the market, think of names that are not dependent on physical contact - bits and boxes to your home.

When pessimism reigns, then the market has finally discounted the worst

I'm seeing peak pandemic, uncertainty, fear, bankruptcy, and oil crashing, which says bottom to me.

The Indexes look bad, but let's focus on oil first, and that means for stocks overall

The futures were limit down all night, and this morning the indexes went down 7% at the open and trading was halted. That says there's a lot of fear out there. Once the halt was over the indexes seem to have bounced for now. The price of oil is crashing even harder than stocks, and frightening everyone even more. The cause of both crashes are being conflated with the pandemic directly, that's a natural mistake, and it will eventually be corrected by traders. What do I mean? The fact is there's a general oversupply of the commodity. The trigger was a second order derivative of a lack of energy demand from China, because of the lockdown in Central China. This will soon blow over and China’s demand will come back.

The truth is, this was a long time coming and likely to happen anyway. The US shale revolution has been muscling OPEC around and taking share from the cartel. So the curtailment of supply by OPEC and Russia to maintain the price was unsustainable anyway. Even with Libya and Venezuela not exporting, the US has been shipping 4 million barrels a day, and US production was still peaking at 13 million barrels a day. Russia was happy to go along as long as the House of Saud would cut its production.

This time the Saudis were pressing on meaningful cuts from Russia and Putin would have none of it. Now, these two oil giants are locked in a production-fueled price war. They are being described at quarreling with each other but the end result will be pressing down the price. This will hurt the frackers, and a lot of small shale producers will now go out of business. What might be dawning on these participants is that this is the essence of free markets. It's the cartel who’s mission is to keep prices artificially high. That wasn’t working because the US does not believe in cartels. What does this have to do with the epidemic? Not a lot. China’s consumption was the trigger, but the dissolution of OPEC was inevitable. A free market has the best cure for low commodity prices, and that is low commodity prices. Lower prices will reduce the ability to explore for more capacity. With super low credit, so many of these frackers that should have gone bankrupt years ago will now go away. With the consolidation of the oil industry in the US, perhaps production will be curtailed or at the least, the growth of production will be curtailed. This will allow more rational pricing, Most oil companies don’t make money at per barrel. This is where this price war is headed.

If we didn’t already have epidemic fear, would the overall market react like this to a price war in oil? No!

The unfortunate result is that it's pressuring the overall market, and market participants are taking this leg-lower and confusing it with the epidemic. Yet, there's some good news on offer regarding the trajectory of the epidemic. China is reporting smaller and smaller numbers of those infected and they already are 50% to 70% capacity in manufacturing. In Korea, the same news, the rate of infection is falling, and they have turned the corner on the COVID-19 flare-up. Italy is still growing its infection rate and there's great fear in the market about the US and how the infection rate will shoot up once the testing goes up in earnest this week. So what's going on? It's the high-frequency traders and the quants who have the algorithms that are reading the headlines and shorting an already weak market. Market commentators being humans are looking at the price and are extrapolating further. This morning commentators were calling for stock prices going down 30% from the peak. I think that means the end of the sell off is finally in sight.

This Week will be the Test for the Market Finding a Bottom

Have the major indexes completely discounted the plague yet? I believe that this week will be the week that the market will have discounted the effects of COVID-19. Last week the Fed lowered this quarter’s GDP to 1.3% and 1.7% GDP for the next. The most strident attention-seeking commentators are aggressively using the “R” word. Remember last year, when the Twitterati and TV talking heads were certain that the trade war was going to hurt us more than China? That we were headed into a deep recession because we dared to challenge the mighty Chinese Communist and the power of their centrally-planned economy? Right now the same commentators are pointing to the actions of the PRC. They are saying how lucky China is that they have the power to shut down huge regions with tens of millions locked inside of their homes to snuff out the plague. I, of course, wonder how many were snuffed out because they couldn’t leave to get help if there was any on offer. Even if there was some residual benefit, I will take my individual rights and freedoms, thank you very much. They are saying that since we can’t take similar draconian action that we are doomed. I say that's bunk.

Would you be surprised by the news that the indexes closed up for the week?

Dow Up 455.42

Nasdaq up 8.25

S&P 500 up 18.15

This is scant consolation for those who try to actively trade the market or even looking to find opportunities for investment. In light of what's going on today, this data sounds totally impertinent to what's happening now. I say that this data does have some value in the sense that there was some bottoming happening even last week. Please remember, that the market is a discounting mechanism. I believe that the discounting already has happened to a large extent and that this phase, right here, right now, is the swing of the pendulum going to far, like it always does. Oil stocks comprise 3% to 4% of the entire stock market. It's pretty nutty to let this control all stocks. Travel and leisure names already were being punished. I think they are being overly punished right now. You can extend this through the whole market. Why isn’t Amazon (AMZN) up today? With China’s manufacturing capacity coming back, why would AMZN sales go through the roof? If people are going to curtail social contact, why not order through Amazon instead of going to the mall? Let me leave you with this one blurb I culled from Reuters:

“Mayor in virus-hit South Korean city says outbreak may be slowing."

In the city of Daegu, which accounts for as much as 75% of all of South Korea’s confirmed cases, mayor Kwon Young-jin told reporters the number of new cases has dropped below 300 for the first time since Feb. 29, Yonhap news agency reported.”

My take: As I indicated earlier, we are seeing a trajectory in the disease that with self quarantine if one is feeling ill, or had possible contact with infected people, and banning large gatherings the occurrence of the illness goes down fairly quickly. I suspect that the Italian infection rate will fall this week as well. I suspect that the media will start talking about what's happening in China and Korea and extrapolate to the infection rate in the US as well. I believe that societal changes regarding shaking hands, touching the face, touching public surfaces, and vigorous hand washing will take hold as well.

The VIX is above 50, it merits watching now for the turn

I find it very interesting that the spot for the VIX is at the historic high going back to the financial crises. I expect to see a retreat to the mid-30s. If the VIX gets back to this level and even begins to fall further then even though the indexes fall down further that will still mark the turn. Also the 10-year rising even a little bit would be a "tell" for the turn. I'm saying that if you are looking for a signal to raise your risk, the VIX at this level is what to watch, then the 10-year.

What to do now? Start with Bits and Boxes then the hated sector

I would buy AMZN right here. Not a full position but start. I think the same of all the social media stocks, Facebook (FB), Pinterest (PINS), Snapchat (SNAP), Twitter (TWTR), how about Etsy (ETSY)? You can all do this at home while you are cocooning away from the diseased crowds out there. If you are going to wade into the market today, think about stocks that will benefit from NOT being in contact with other human beings, maybe a Roku (ROKU)? Or a Netflix (NFLX), or maybe even a Comcast (CMCSA).

Then for a little longer investment horizon think about Travel and Leisure

Last week I introduced the idea of considering the most hated sector for investment or trading - Travel and Leisure. If you force me to make a few suggestions right now it would be Disney (DIS), Six Flags (SIX), and Cedar Fair (FUN). I wouldn’t jump in with everything right now, but take DIS. This virus will be over by this summer, Disneyland will be crowded by the time the summer turns around, and all the blockbuster movies that they are delaying will come out this summer, and Disney+ will continue to find subscribers.

My Trade: I did not make any trades yet today. I'm going to look to roll down my short calls and use those funds to lower the strike prices of the long portion of my calls. I'm not starting any new positions. There's nothing wrong about not trading at all right now. If you have cash for investment, I would allocate a little today. If you are going to look at dividend stocks make sure they have the financial strength to pay that dividend.

Please don't short this market right now. The administration can announce some new program and that could bounce the indexes.

Disclosure: I am/we are long ROKU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have positions in ROKU and AMZN in CALL spreads

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