【April 21, 2020】Crude oil market hits historic crash - Tetsu Emori's Real Trading Strategy

“Emori Tetsu's Real Trading Strategy”

Excerpts from the April 21, 2020 issue

〔EQUITY & BOND MARKET〕
【U.S. & Europe Stock & Bond Markets: Market Commentary & Analysis】

U.S. stocks declined as crude oil prices sank into negative territory for the first time.The day’s WTI crude oil futures were pressured by concerns about demand declines due to the spread of the coronavirus, plus fears that storage capacity would reach its limit, worsening oversupply. The May contract posted the first ever negative price. The settlement price was down 306% (near $55.90) to negative $37.63 per barrel, and briefly fell to negative $40.32.The unprecedented oil slump weighed on energy stocks and other earnings-sensitive names, and the Dow Jones Industrial Average fell as much as 615 points. The Dow had risen nearly 3,200 points over the prior two weeks, which also encouraged position-adjustment selling. This week, as major U.S. companies report first-quarter results affected by the coronavirus shock, investor caution appeared to be spreading.

On the other hand, Internet retailers and streaming services that benefited from stay-at-home restrictions, such as Amazon.com and Netflix, were bought and helped support the market. Amazon rose 0.8%, Netflix rose 3.4%. There was also buying in healthcare stocks, buoyed by hopes for vaccines and treatments. However, Boeing fell 6.8% to lead the Dow lower. Dow component Dow Inc. fell 5.7%, ExxonMobil 4.7%, Chevron 4.1%, all softer. The S&P Energy Index fell 3.7%. The Energy Index is down about 45% since the start of the year, the largest drop among 11 sectors.

U.S. oil-services company Halliburton’s first-quarter results showed a bottom-line loss as oil prices fell, but excluding items, earnings beat expectations. Net loss was $1.02 billion, or $1.16 per share. A year earlier, net income was $152 million, or $0.17 per share. Excluding items, earnings per share were $0.31, above Refinitiv’s consensus of $0.24. The company took a $1.1 billion pre-tax impairment related to shale pressure-pumping operations and cut this year’s capex plan by about 50% to $800 million.

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【U.S. Stock Trading Strategy】

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The market seems to be getting quite uneasy.Prices have recovered quite a bit, so going forward we should be wary of a second leg down. I’ve explained past moves many times, so I won’t repeat, but historically, a drop of more than 30% from the peak has never found a bottom at levels like these.We will monitor this data closely and act with the possibility of further declines in mind. As more U.S. corporate earnings are released, the reality of Q1 will become clearer, and markets will react if forward earnings outlook deteriorates.

In the short-term trading strategy, longs on the Dow and the S&P 500 are closed. Nasdaq remains long, and Russell 2000 is a new long. However, the VIX has finally become a new long. A risk-off pattern is forming. I plan to reduce positions in stock index futures and tilt toward VIX long. Prepare for a breakdown. Given the time frame and levels, a rebound is likely. These strategies do not consider fundamentals and are based on technical analysis. Combining such short-term strategies can help navigate a down market.

In the long-term portfolio strategy, the plan to buy more on dips continues. This is not the current phase. If prices break below the bottom, I would buy more, but I will do so cautiously. I have allocated funds to be able to buy on dips at about five increments: 30%, 35%, 40%, 45%, and 50% from the high. I have only bought about 30% so far, so there is no problem if prices fall further. If they do not fall, I will not force purchases. This time prices have fallen about 30% from the high. In this pattern, a decline of up to 50% is not implausible. In the Great Depression, declines exceeded 70%. It may not be necessary to go that far, but I want to maintain liquidity at all times.

Concerns about an economy slump comparable to the Great Depression persist. Since the Great Depression, there have been five instances of declines well over 30% from the high. On average, it takes about 1.5 years to form a bottom. The recent high was in February this year, so the downtrend could continue until next summer. Therefore, I will time my buy-the-dip with that horizon; long-term investing requires such a time frame.

【Japanese Stocks Trading Strategy】

The Nikkei average has become weighed down on the upside. There seems to be some buying on dips, but the current upside is mainly from heavy foreign institutional futures buying, making the upper level of stock prices fragile. Individual investors have shifted their focus to small-cap stocks, which has supported the index, but caution is warranted. There is a risk of buying at a peak leading to expanded unrealized losses, which could again weigh on the domestic market.

The expectation for a COVID-19 recovery remains strong, but Japan’s delayed response means the unwinding of restrictions will also be delayed. Infection numbers are still rising, so the government is unlikely to ease its stance soon. The state of emergency is not expected to be lifted by May 6, and may be extended, further affecting economic activity. Major Japanese companies may not be able to report earnings this quarter. The outlook for this period is unclear. With valuations not yet measurable, buying individual companies carries significant risk. A cautious stance is required.

The Nikkei has again moved further away from 20,000. If there is a dip, some investors might buy, but at present the only reason to buy would be a near-term COVID-19 recovery. While I would like to rely on that, I will remain cautious. The rebound high from 20,500 to 20,800 now seems distant due to declines in U.S. stocks.

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