• Weekly Comments for January 19, 2016

    Last week was about bad debt contagion.

    Bad debt could spread out either from China or from distressed energy loans and bonds.
    The consequence is an ugly spike in the Ted spread.



    The fallout from China is probably one of the reasons why the British Pound is under pressure and UK banks are more exposed to China through privileged links with Hong Kong institutions.



    The Canadian dollar follows a similar pattern due to poor energy and commodity prices.
    We can, however, detect a spike of buyers at the right of the Canadian dollar figure. Is a reversal underway?



    Oil seems to be stabilizing at around $30.
    In technical terms, oil is forming a bear flag, which points to another price breakdown. Iranian oil will create more selling from the Saudis. This could lead to more tension between the two oil producers and their respective political and military backers. (Let me wear my Armageddon hat here.)

    The above is a typical armchair analysis that anybody can perform and that is most probably already priced in. In other words, nothing that you can gain from.



    Anyway, oil price prediction is very difficult because it's hard to know when production cuts will really happen. Just have a look at Moody's forecast dating from July 2015 (oil was trading around $50 at the time.) Moody's stated that prices would climb back to $60 in 2016 even with Iran 's return to the markets.

    https://www.argusmedia.com/pages/New...74420&menu=yes

    Here we are in early 2016, with prices 50% lower. So oil prices only need to climb 100% to reach that forecast.

    So, I will not make a fool of myself and predict anything for 2016 even for the next few days. What I can only say is that the Money Flow on XLE is diverging from the price. The 20Day MF has turned positive, which indicates that prices will bounce. Or at least this indicates that large investors are buying the largest oil integrated companies (XOM, CVX, etc.)

    Why would this happen?



    A comparison with the sub-prime crisis.


    To put today's crisis in perspective, I would like to post a few figures dating from 2007 and 2008.

    In 2007 there was about 2T$ of asset-backed commercial paper, of which about 1T$ were toxic assets. These were mostly mortgage-backed securities that were impossible to price because they had been stripped of their title.

    On October 10, 2008, the TED spread was 4.65%. The TED spread today is still ten times lower.
    The above "spike" is very relative.



    In 2015, the energy loan size held by US banks was around 200 B$. This is almost 10 times lower than the MBS levels of 2008.



    http://www.wsj.com/articles/energy-l...eze-1443050639

    US banks' loan exposure to energy is about 2.8% today. This is a far cry from the 50% distressed MBS of 2008.



    However, even with this low exposure, the Fed decided two days ago to free banks from using MTM accounting for energy loans.

    This is an extract of the WSJ Article above: "If the regulators are going to be tougher on the banks, expect the banks to be tougher on the borrowers."

    But with regulators allowing these distressed energy loans to stay in the books without impairment charges, there certainly will be more room for negotiation. How can this be negative? Banks can now hold the energy bonds and loans on their books without the negative impairment charges and claim the assets if payments are not executed. This is an unlimited call option on oil assets. Is this negative?

    Below is a WSJ article of April 2009 regarding MTM rules relaxation that spurred the epic market reversal. Why would this be different this time for energy stocks? What about for regional banks?

    http://www.wsj.com/articles/SB123867739560682309

    Conclusions:

    I do not believe we are going to see a redo of 2008 on a risk that is clearly 10 times lower.
    Comments 2 Comments
    1. adam ali's Avatar
      Pascal,

      To your point about oil, this gentleman is someone to pay attention to:

      http://www.cnbc.com/2016/01/15/oil-a...&doc=103308789

      I'll add again the look of the 20-Day Money Flow chart is odd, with the flow sideways to up, and the S&P 500 down hard. Is this a sign of complacency?
    1. Pascal's Avatar
      Quote Originally Posted by adam ali View Post
      Pascal,

      To your point about oil, this gentleman is someone to pay attention to:

      http://www.cnbc.com/2016/01/15/oil-a...&doc=103308789

      I'll add again the look of the 20-Day Money Flow chart is odd, with the flow sideways to up, and the S&P 500 down hard. Is this a sign of complacency?
      Hi Adam,



      Thank you for the link.
      Regarding your question about complacency, I find it difficult to answer.
      Complacency can only be judged in hindsight.
      What I find more interesting is for example to compare the MF of XLE to the MF of XLF.

      The MF is an oscillator around 0. When it is below 0, this means that money is leaving the instrument.
      The yellow blocks show negative MF.

      We can see that for XLF, the negativity corresponds to price weaknesses.
      For XLE, it seems somewhat different, especially at the right side.
      The reason could simply be that profit expectations for these large energy firms is higher than for other sectors.
      It could be that those putting money in XLE today at the start of 2016 have a longer-term view of let's say one year.
      If you believe that none of these large companies (XOM, CVX, etc.) will go bankrupt and that oil is close to a bottom compared to where it will be in one year, then expectation for a bounce in XLE can indeed be much higher than expectations for a bounce in XLF for example.

      But, this could still be an options expiration anomaly.

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