Jobs, Oil, Markets and Portfolios
Jobs: Unemployment claims increased by 4.4 million in the past week, though the trend is sharply down since spiking during the last week of March. Around 26 million jobs have now been lost due to the economic impact of social policy to combat COVID-19. The actual unemployment rate is between 15-20%, something not seen since the great depression, and wiping out all job gains since the 2008-9 global financial crisis. On the day this data was announced, Thursday the 23rd, the S&P500 ended the day nearly flat.
Oil: This week, futures contracts for West Texas Intermediate (WTI) Crude expiring in May traded for negative $37.63 a barrel. This marks the first-time energy has ever traded for less than zero. It’s well known that we’re using less fuel due to the shut-down; fewer people are driving cars and airlines seem to be flying at about ½ of their normal capacity. At this point, we’re running out of places to store oil, as production is still far exceeding demand despite recent production cuts from OPEC+. Therefore, near-dated energy contracts are negative.
Companies need to be paid to store physical oil.
WTI is one of several energy contracts in the world. This contract requires that the owner take custody of the oil in Cushing OK, a location far from any major population center. The oil brought to Oklahoma for sale is from US and Canadian firms that use fracking techniques to get their product out of the ground; this oil is generally low quality compared to Middle Eastern oil and requires specialized refinement to be used. For these reasons, WTI always trades at a discount to Brent crude (Oil from the North Atlantic and a reference price for OPEC) which is still trading at around $25 a barrel.
Don’t run out and buy a Hummer just yet. The consequence of the collapse in WTI will be serial defaults by energy firms in North America and a dramatic drop in exploration and production. The White House is considering options to assist the sector, such as paying firms to leave oil in the ground. A fossil fuel industry bail-out will be challenging to get through congress without similar funds provided to green energy producers. This may set the stage for another boom period in the energy market down the road a year or more from now.
Markets: We have written that volatility is to be expected. The S&P500 continues to demonstrate wild swings from day to day: down 3% on Tuesday; up over 2% on Wednesday, and up over 1% on Friday. And what did we get for the trouble of living through that drama? Nothing. The S&P500 finished the week within 9 points of where it started. This type of sideways outcome, with bouts of noteworthy volatility along the way, is likely to be the norm, rather than the exception, for the time being.
Portfolios: As indicated in last week’s communication, we have initiated the process of reallocating client portfolios. We are making several changes to portfolios in custody at Charles Schwab & Co. Among these: 1) replacing active managers in the domestic large cap growth and non-US large cap blend spaces in favor of more appealing alternatives, 2) vacating small cap passive in favor of our existing small cap active mutual fund, 3) trimming two existing fixed income positions and allocating the proceeds to a new fixed-income investment.
We are currently analyzing the TIAA Real Estate account and are considering reducing our exposure. As you are probably aware, we have a substantial allocation to this investment throughout the vast majority of PIM
clients’ accounts. Most of the time, the unique characteristics of this investment provide added value. Sometimes however, the commercial real estate sector is not the place to be, at least not to the extent of our normal exposure. The TIAA Real Estate account owns five general types of investments, in order from largest to smallest allocation of holdings: office buildings, apartments, retail centers, industrial parks, marketable securities for liquidity, such as REITS and Treasury securities. Current economic circumstances, particularly if protracted, will have a negative impact on most of these. Clearly, retail shopping centers are suffering now, as are the marketable securities in the portfolio. Apartment buildings are at risk, in-line with unemployment. Industrial parks may be at risk, depending on where in the supply chain the occupants reside. Should companies leasing space in TIAA office buildings fall under considerable financial stress, then leases may need to be renegotiated, may be outright broken or possibly won’t be renewed at the next expiration date. Companies working in a decentralized manner now may determine this to be operationally viable and more cost-effective long term. Any of the preceding will lead to higher vacancy rates, lower revenue and lower valuations. The extent to which these factors materialize and persist is unknown. We will make a determination about this soon. Should we choose to reduce our allocation to the TIAA Real Estate account, the proceeds will be placed into TIAA Traditional (essentially a risk-free cash equivalent) for the time being.
Closing Comments: This edition of our communication avoids citing COVID-19 statistics. We mentioned in earlier communications our reluctance to track such statistics, as these change by the hour, and there are far better sources for such information.
Over the next 3-4 months, we expect state economies to gradually re-open and corporate earnings to reflect significantly lower business activity. We have provided guidance that it may take 12-18 months for investment markets to return to former highs. One could make a case that our guidance is conservative. Optimism that the economy could recover over a shorter timeframe is anecdotal, but not impossible. The optimistic case reflects the nature of the efforts underway to battle the virus and resulting economic hardship. Generally speaking, the argument is that every stakeholder is working towards the same outcome at the same time. Stakeholders include: 1) human beings, who are social distancing and masking to prevent infection and spread, 2) the healthcare community treating patients and providing medical guidance, 3) the pharmaceutical community, racing to a vaccine, motivated certainly by economics over altruism, 4) lawmakers, who are passing unprecedented legislation in support of private persons and businesses, 5) the US Federal Reserve, engaging in activities to prevent capital markets from seizing and crashing.
When was the last time that this group of stakeholders was all working towards the same goal with such urgency and focus? Is it conceivable that the collective efforts of all involved will fail? It seems unlikely; we certainly hope for success.
Please accept our sincere gratitude for the trust you place in PIM. Please be in touch with any questions or concerns.
Personal Investment Management, Inc.