BRINGING YOU MARKET ANALYSIS FROM OUR TRADERS
THE HISTORIC NEGATIVE OIL PRICE Read more, p. 26/27
EXCLUSIVE: THE POST-COVID-19 ECONOMY: WILL IT BE DEFLATIONARY OR INFLATIONARY?
WHAT IS A V,U & L SHAPE RECOVERY?
MAY 2020 EDITION
TRADER'S INSIGHT
CONTENTS
PAGES 5-6: Market Overview PAGES 8-12: The Post-Covid-19 Economy: Will it be Deflationary or Inflationary? PAGES 15-19: Recovery for Risk Assets or a slight reprieve? PAGES 21-23: Era of Diversification PAGES 25-26: The Historic Negative Oil Price PAGES 28-29: What is a V, U or L shape recovery during a Pandemic? PAGES 31-34: Equity Market Crash: What Next?
CONTRIBUTORS GAVIN PANNU: HEAD OF TRADING ACADEMY
Gavin is an experienced trader of a multi strategy fund. He is a certified market technician with both the STA and IFTA organisation and has worked with trading companies and brokers as a Senior Market Analyst and Mentor. He has been a regular contributor to financial publications.
RON WILLIAM: MARKET STRATEGIST
Ron is a Market Strategist, with +20-years of experience, working for leading economic Research & Institutional firms; producing macro research and trading strategies. He specializes in blended, top-down, semi-discretionary analysis, driven by cycles and proprietary timing models.
THIS MONTHS CONTRIBUTORS ROLAND ROVENTA: MARKET ANALYST
Roland entered the cryptocurrency ecosystem in early 2017 and has been trading based on fundamentals ever since. He's excited to see the cryptocurrencies evolving as an asset class, merging with the traditional world of finance.
DESMOND ADEOSUN: JUNIOR TRADER
Junior FX Trader at Alphachain Capital with a Mathematics and Economics (BSc) degree. Possesses a strong focus in technical analysis and prefers to trade in line with the fundamental theme.
MATTHEW WISE: JUNIOR TRADER
Junior FX Prop Trader at Alphachain Capital with a MSc Finance at the University of Edinburgh. Possesses a strong background in creating statistical and financial models.
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MARKET OVERVIEW GAVIN PANNU The fiscal and monetary policy action to minimise the economic impact of the coronavirus has begun to take effect in the month of April. Key fiscal stimulus packages have been executed to ensure households and businesses have access to cash to be able to stay afloat for the short term. While monetary measures have been pledged to keep interest rates low until the economy has weathered the pandemic has led to market participants feeling optimistic.
Source: BlackRock Investment Institute, with data from Refinitiv Datastream, April 2020.
Economic activities in different regions are almost at a standstill due to the Covid-19 virus. The implications for assets will largely depend on the cumulative impact of growth over a period of time. It is clear that due to the actions of Government’s and Central Bank’s policies which has enabled the impact of the virus to be cushioned, has led to a belief the virus shock would be short-lived as the overall financial system is not in a crisis compared to the 2008 recession. It is important to note the evolution of the virus and the duration of the containment measures are still uncertain.
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As we see fiscal and monetary response pre-empting and taking action prior to an economic activity shock, this has so far limited the overall recession risk. We must consider the concept of a recession does not apply currently as there is no financial crisis which is accustomed to the usual business cycle. This pandemic is more correlated to a natural disaster which disrupts the near-term activity, but eventually the economy will be able to quickly recover. Even with the economy beginning to reopen, there is a potential danger of new outbreaks which leads to waves of flare-ups which eventually could be controlled with social distancing and lockdown measures being put into place. This would affect certain parts of the economy which may close and reopen on a rolling basis, starting with workers who are at lowest risk of infection until there is a vaccine. This health care crisis could have permanent changes in consumer and corporate behaviour.
Source: BlackRock Investment Institute, with data from Refinitiv Datastream, April 2020..
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THE POST-COVID-19 ECONOMY: WILL IT BE DEFLATIONARY OR INFLATIONARY? MATTHEW WISE Public heath efforts to prevent the spread of coronavirus have sent shockwaves through the global economy. The US economy shrank by 4.8% in Q1 2020 and it is expected that GDP will fall by as much as 30% in Q2- the largest contraction ever recorded. Across the globe, governments and central banks have channelled all of their resources in an attempt to contain Covid-19’s shortterm economic impacts. The Fed’s unprecedented lending programme has expanded their debt obligations by $2.4tr and is injecting capital into the financial system at a rate of $1m every second. However, little attention has been paid to the longer term impacts of Covid-19. Severe inflation and deflation are very plausible possibilities and will require attention from policy makers in order to effectively navigate through the post Covid19 era. Inflation and Deflation— Changes in the Price of Goods and Services Inflation and deflation are natural consequences of the traditional economic cycle. The former is defined as an increase in the price of goods and services over time and usually occurs alongside periods of economic growth. It is a result of high demand and unmatched supply.
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Intuitively, deflation represents a fall in prices over time and often follows recessions. The poor economic conditions mean lower wages for workers, which disincentives spending as households have less disposable income. This reduces demand for goods and services and therefore, prices fall. Prolonged periods of deflation have detrimental effects to the economy- often in the form of a deflationary spiral. In this scenario, declining prices strengthen the purchasing power of a currency and consumers have reduced incentive to spend their money today when they can reasonably expect that their money will be worth more tomorrow. It Deflation is Covid-19’s Menacing Counterpart With even the most advanced economies heading into recessionary territory, it is difficult to argue against a deflationary gripping markets in the near future. In response to a lockdown-driven fall in consumer demand, prices for goods and services have already plummeted, with retail, hospitality and restaurants being the hardest hit sectors. Earnings season has demonstrated the fragility of even the largest businesses, for example with Adidas’ net profit falling 97% from the same quarter last year. Unemployment applications reach 26m in the US and those who still retain some disposable income due to wage subsidies, are unlikely to spend equal amounts in the sectors they are currently deprived of. All of this is notwithstanding the historic oil market collapse which will undoubtedly drive industrial costs lower. If coronavirus continues to spread and lockdown restrictions continue into the second half of the year, these deflationary catalysts may result in a full deflationary spiral. This issue extends to the investment sector too; as prices and wages fall with deflation, the ‘real’ value of the debt increases and effectively, mortgages become more expensive to pay off. This higher cost of debt, in turn, discourages borrowing and productive capacity decreases. The result is a toxic negative feedback loop which will render the economy paralysed. The prevention of this scenario lies in fiscal stimulus. The Fed’s unlimited quantitative easing will prop up asset prices and although this impacts the average consumer positively, it does so indirectly through credit markets. However, the majority of homeowners do not own financial assets and rising stock markets will not convince the 26 million people who have already lost their jobs to go out and spend. The US administration needs to support local businesses and family incomes directly if they want consumer demand to rise and prevent a deflationary spiral. The $2tr package was a great start but as Jerome Powell said himself, “more stimulus is needed from Congress”.
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FROM DEFLATION TO INFLATION However, the recession we are facing is not conventional by any means. The economy prior to Covid-19 was not overheated and the balance sheets of commercial banks are healthy. Most importantly, this recession is being predominately driven by the lockdown-induced fall in aggregate demand. Thus, provided that governments provide workers and households with enough capital to avoid a deflationary spiral, a large proportion of economic productivity should be restored once restrictions are lifted. The next challenge financial markets face is one of inflation. Once lockdown has ended, consumers will be able to spend once again and businesses will flourish under the newfound demand. As industrial production begins to restart, the enormous pressure on oil storage will be alleviated and oil prices will soon rise from their historical lows. Although the demand-side shocks should quickly recover, supply chains will likely remain strangled for some time. As China is positioned as a critical producer of global industrial products, the restriction of key Chinese workers at the start of the pandemic caused YoY exports to plummet by 17%. Although China is beginning to restart their industry, the West, who are approximately two months behind their epidemiological curve, are in no position to increase imports. This ‘second shock’ to Chinese supply chains is of great concern to global trade and China will continue to suffer until the Western economies further up the supply chain have time to recover. These lasting impacts on global supply will undoubtedly have longer effects than the temporary demand disruptions, and will continue to prop up inflation for some time. In summary, Covid-19 has propelled the world into uncharted territory. A post-coronavirus economy will inevitably feature a deflationary period— governments must react quickly and with conviction to prevent the economy from spiralling downwards. Inflation is possible on the longer-term horizon, but the extent to which it will feature can only be clarified with time.
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ASSETS TO WATCH - MEDIUM TERM Outlook on Gold: BULLISH Financial hedge properties favour gold in both deflationary and inflationary conditions. Fear to increase as recession deepens and economy continues to contract. Pricing in of additional QE and money supply injections increase risk of high long-term inflation. Strangled gold supply chains show few signs of improvement. Rising demand for real store of value with a question mark over crypto’s safe haven status. Up-graded targets of around $3,000 XAUUSD (4h) Trendline formed since April 1st. If price breaks $1,740 handle, next resistance is August 2012 high at $1,793. Provided fundamentals are in-line, next major target is all time high at $1,913. If price breaks this resistance, unlimited upside potential.
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Outlook on USD: BULLISH In a deflationary economy, consumers spend less due to falling wages and the perception that purchasing power will further increase. High demand for USD. Safe haven status to remain strong as recessionary fears increase. Liquidity shortfall pushed the repo rate up. DXY (2h) Price has been ranging since 27th Feb. Resistance at 101.90, and support at the 98.8 and 98.3 handles. Â Price in small downtrend currently and is predicted that after bouncing off support levels, will retest 101 level. As this is also a Fibonacci 0.216 level, will require fundamentals to break resistance. Next target is March 23rd high at 102.97.
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RECOVERY FOR RISK ASSETS OR A SLIGHT REPRIEVE? DESMOND ADEOSUN The first quarter brought a beating for risk assets as they looked to weather the storm laden by the Coronavirus and sequentially the Oil market. Commodity currencies retreated severely as their economies took a turn for the worst due to a substantial decline in oil demand and global trade, as countries embraced nationwide lockdowns in order to contain the spread of the pandemic. Within a three-week period commencing from 24th February 19th March, the Australian, New Zealand and Canadian dollar lost over 40% against the US dollar combined as risk flowed into safe havens and investors sought liquidity amidst the global slowdown. As we progress past what seems like the peak in Covid-19, risk assets have attempted to regain ground against their safe haven companions though the true question remains; Is it the beginning of a potential recovery or are we witnessing just a slight reprieve?...
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In the last Monetary policy conference held by Canada, Gov Poloz outlined that “Commodity producing countries have been hit twice…” as the supply and demand issues faced by oil despite the seemingly late output cut sent prices plunging with figures reaching a record -$40 (WTI) at the May contract expiry. With prices languishing near single digits, the oil and gas sector is under threat and has been dealt a major setback. This slow in demand is likely to be followed up with a deterioration in investment and production within the sector as cuts will need to be made in order to prevent and shield any further losses. Now in amongst all of this the labour market has suffered severely as unemployment increased by over 2% to 7.8% and over 1mln jobs were lost across the nation leaving many Canadians at the mercy of various unemployment benefit schemes and aid from the government. Increased unemployment matched with a lack in demand due to low consumer spending has left many Canadians at home uncertain about what the next steps will be for their family and communities. This has led to a piercing drop in consumer and business confidence as households also look to seek mortgage holidays and delay payments due to financial institutions. At the time of writing GDP m/m figures have been released below previous and forecast at 0.0% showing signs of the strain on the economic health of the nation. This unprecedented time has been met with a strong policy response by the government as they look to limit the effect of the slowdown and provide the economy with a sense of optimism for what lies ahead. Fiscal, monetary and financial policy measures have been deployed in order to counterbalance the lost income and increase the accessibility to credit resources. Households and businesses will be aided with packages that are aimed at supporting them through this challenging period as the government looks to provide elastic support that will adjust depending on the severity of the shock to the economy and employment sector. Though the outlook looks bleak, the Canadian economy is likely to stabilise as lockdown restriction measures ease and oil prices normalise, though the time horizon is still quite uncertain and the harshness of the recession will very much depend on how quickly the spread of the Coronavirus diminishes and how global oil supply and demand looks to rebalance as the year progresses. Following on from the surge in prices for USDCAD, markets have seen the Canadian dollar attempt to gradually claw back the losses seen late on in the last quarter, though an interesting dichotomy presents itself as we witness a boost in liquidity by the FED sending USD supply to all-time highs as asset purchases continue to build in order to support the market. This should in theory have a weakening effect on the USD as supply overcomes demand though in a time where risk flows have tilted towards safe havens it is likely that we are to see the overall effect once the threat of Covid-19 is over. As I conclude this discussion on the impact that the Coronavirus and oil prices have had on risk assets, the DXY sits below 100.00 with a further downside potential to 98.30.
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USDCAD Â Strong bullish momentum seen this year so far as price stays firmly above the 200SMA.
Taking a closer look, the potential formation of a descending triangle highlights that bears are stepping in earlier on each attempt higher made by the bulls. A break of this pattern could see prices move to a lower support level of at least 1.3320
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AUDUSD Â A sharp increase in bearish pressure seen earlier on in the year.
Prices have made a strong bullish push back up with nearby resistance ahead at 0.6685. If price violates the level and the bullish momentum continues, bulls could potentially push prices up to 0.7000.
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NZDUSD Â Bears demonstrating long term control as prices stay below the 200MA
Price is currently approaching a trendline. Should price break above then we could see a move up to 0.6450, if prices hold then we will expect a continuation to the downside.
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ERA OF DIVERSIFICATION ROLAND ROVENTA
According to the BofA, the 2020s will be an era of diversification, changing from the previous 2010‘s era of liquidity. The era of liquidity was created by central banks who have cut rates more than 799 times since the Lehman Brothers collapse and bought more than $12 trillion of financial assets. This has created a “liquidity supernova”, causing the longest and almost the greatest equities bull- run in history. The Fed has created a liquidity trap, in which it risks a recession if it stops quantitative easing. As QE continues, bubbles will continue to grow. This low-inflation environment benefits US equities while disadvantaging commodities and other disinflationary assets. BofA estimates that the liquidity era will last another 3–6 months, after which we will see a top in the prices and higher inflation will start as a result of global negative interest rates. From this point, the diversity era will start, where disinflationary assets will outperform today’s QE gainers.
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Correlation Matrix September 25, 2013 – August 13, 2019
Crypto-assets, being a disinflationary asset class, can be what institutional investors need to reach their future performance targets while decreasing their portfolio risk. They have proven to be uncorrelated to any other asset class, and they are also imperfectly correlated among themselves. Crypto-Assets in a Traditional Portfolio
They have proven to be uncorrelated to any other asset class, and are also imperfectly correlated amongst themselves. The inclusion of crypto- assets in traditional investment portfolios decreases the portfolio’s overall risk because of diversification. A small allocation of crypto-assets helped the performance of traditional investors over the last six years. The total return and Sharpe ratio significantly increased with the inclusion of crypto-assets.
CRYPTO FUNDS OVERVIEW The growth of the crypto ecosystem along with increased international regulatory framework allowed for a variety of funds to enter the market. Over 800 various crypto funds have been created, including hedge funds, venture capital funds, and index funds. As crypto-assets started outperforming traditional investments, crypto- funds have grown.
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Launches of Crypto Funds
The crypto fund launches peaked around 2017’s bull-market, aided by an increased investor’s interest. In 2019 the industry was midway through the ‘crypto winter’ and experienced a decrease in investor interest and thus it is estimated that 90 funds have closed during that year.
CRYPTO HEDGE FUND PERFORMANCE Crypto-assets are known to have massive fluctuations in price. Hedge funds have the ability to use their know-how to turn these fluctuations into their favour and increase alpha generation for their clients. Depending on the strategies of the hedge fund, the returns vary. Median Returns
Median Returns by Strategy
Depending on an investor’s preferences, he or she may choose a hedge fund that suits their needs. The 2018 median returns show that fundamental and opportunistic funds decrease the downside potential of the asset, but still have negative returns in a bear market. On the contrary, quantitative strategies are market neutral and can be profitable in all market conditions. In 2018, the median quantitative fund was negatively correlated to the market, with a beta of -2.33.
Crypto hedge funds limit their risk exposure during high volatility periods. Thus, hedge funds with fundamental and opportunistic strategies over-perform against the underlying asset in bear markets and underperform during bull markets. This decreases their risk, consequently increasing their Sharpe ratio.
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THE HISTORIC NEGATIVE OIL PRICE GAVIN PANNU The May Futures for WTI dropped as low as -$37 before the May Futures contracts expired on the 20TH of April. As oil prices went negative for the first time in history due to the massive supply from OPEC+ producers and a complete collapse in demand due to the Covid-19 pandemic. We can safely say these are the most bearish conditions imaginable for oil. How Negative Oil Prices Work Oil production can cost millions of dollars in machinery and labour, so why would producers ever pay buyers to take it off their hands? In short, it was not the producers which led to negative prices but future’s traders. The futures markets are contracts that allow a commodity buyer which in this case is an oil buyer to lock in a delivery at a specific price at a specific future date. Producers and consumers use this market to hedge against future price changes, but traders also use them as speculative instruments. On Tuesday, 21st of April was the expiry date for May oil futures contracts. That’s the date by which the holder needs to either sell the contract or accept physical delivery of actual oil. The traders who were still holding May contracts on the 20th of April faced a conundrum. No one was willing to buy the contracts off of them especially not for a positive dollar amount, and they weren’t willing to accept physical delivery.
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After all, there is a significant oversupply of oil in global markets right now due to an economic standstill from the COVID-19 virus and the recent Russia-Saudi Arabia price war did not help matters either. That oversupply has led to an extreme shortage in oil storage space and rising costs for it. The main reason traders sold oil futures contracts for negative prices was because it was cheaper to pay someone to take the contracts off their hands than it would have been to find a place to store the underlying oil. Now that May contracts have expired, the price of oil is back above zero. The Chicago Mercantile Exchange allowed the first negative-strike-price option contracts to start trading on, hinting that many investors expect negative oil prices to return in the near future. Impact on the Consumer Unfortunately this does not mean you will start making money at the nearest petrol pump if prices become negative again, nor will you get free petrol.
Oil prices are only one factor in the overall price of your fuel. Refinery operational costs, shipping costs, and taxes also contribute to the price of filling up your tank. However, negative oil prices could push petrol prices down by a significant margin until the supply of oil drops back down into equilibrium with demand. Conclusion The June WTI contract is started to show stress and trending lower. Goldman Sachs estimates global storage capacity will be reached in just three weeks into June, which would require a cut of a further 20 per cent of global output. That would suggest an OPEC+ cut of 9.7m bpd is not nearly enough coming into effect at the start of the month of May. It will make the front-month contract liable to further volatility.
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WHAT IS A V, U OR L SHAPE RECOVERY DURING A PANDEMIC? GAVIN PANNU This is an attempt to forecast how the overall economy or a specific business will be restarted after a significant sell off in asset prices. I will explain what you should expect in a V, U, or L-shaped recovery. V-Shaped expects a Quick Recovery Essentially the assumption is that when lockdown measures are lifted, consumers will return immediately and employees are ready and able to provide products and services. These businesses would return to the normal path they were prior to the pandemic. Netflix is a good example as it would have been impacted due to systemic risk but has quickly recovered has subscriptions have grown due to the lockdown measures. Amazon share price;
U-Shaped expects a Slow Recovery It may take businesses some time to be back to normal and for customers to return. Businesses that were open during lockdown measures have an advantage as they were already operational. For other businesses, it will take some times for employees to return to work who have been furloughed. Customers may shifted priorities so will come back more slowly. The slower U-shaped recovery is more realistic for most companies in the current pandemic. Supermarket brands such as Tesco’s and Walmart fall into this category as customers may slowly begin their normal activity of grocery shopping.
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Tesco’s share price;
L-Shaped expects a No Return to Prior Conditions For some businesses, it may be L-shaped where it may be unclear if the business will recover. The key question would be have consumer habits changed permanently? During the pandemic consumers could have shifted to shopping fully online and this turns into a habit where they may not go back to how it was previously done. Boeing Share Price;
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EQUITY MARKET CRASH: WHAT NEXT? RON WILLIAM The latest VUCA (Volatility, Uncertainty, Complexity & Ambiguity) environment teaches us the virtues of being “calm in the eye of the storm”, while also wary of " catching the falling knife", after a 30% crash. What next? Select media interview link for full report. S&P500 post-crash rebound fails into Q2 cycle window An interim market bottom is taking shape into our Q2 cycle window, but will likely offer false hope, as an important reassessment of financial views and investment positions continues. Like the Olympic skiers poised at the start of the downhill, investors sense that the dangers are great, but if the turns can be successfully negotiated, the rewards will be worth the risks. Our tactical model flashed a sell signal in early February, only acquiring a modest profit due to the unprecedented volatility that followed, with the VIX spiking to 2008 GFC levels. A series of forced liquidation chart patterns also triggered post-intraday late session relief-rallies, amplified by the crescendo of mega hedge funds, passive strategies and ETF vehicles, all unwinding old regime market strategies.
Median Returns by Strategy Median Returns by Strategy Median Returns by Strategy
S&P500 key price retracement levels are 2645 (33%), 2805/35 (50%/value level), into the 3000 psychological ceiling, near confluence 3010/85 (66%/value level). Downside risk is naturally based on any further new low breakouts, within tight margin from 2347 & 2281 (2018 low & 2020 crash low). A sustained weekly close beneath here will still pose another -30% risk ahead.
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-30% RISK STILL AHEAD The big picture chart above highlights a major bull-trap exhaustion signal recently testing key 30-year trend mean, near the double top breakout level at 2380. The latest short-term oversold rebound will likely continue into our Q2 cycle window, before resuming lower this year.
Confirmation below 2380 would unlock further downside scope into the next psychological level at 2000, also a triple confluence price range (50% retrace, -1STD & value zone). Long-term targets remain back at the old bubble peaks of GFC 2008 and TMT Y2K, near 1600, equating to yet another 30% drop and total fall of 60%, marginally overshooting traditional bear market drawdowns. Market pundits continue to benchmark the latest Coronavirus trigger against prior exogenous shocks, such as either SARS, or the 9/11 attack. Aside from the intrinsic differences, we should remember that both events were at the bottom of the market cycle, which later gave birth to 2003-2007 bull cycle. The context now is very different, at the top of a record-breaking bull-market in both price magnitude and time duration. The global pandemic is clearly a major shock, but in the end, it will be remembered as the pin that burst the mother of all bubbles.
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LT CYCLES SIGNAL ASYMMETRIC RISK INTO 2020-2023 Long-term cycles signal further asymmetric risk ahead between 2020 and 2023, into a 90year trend regression channel (-1 STD). Prior generational cycles have marked key shifts in bull and bear regimes, fuelled by expansion and contractions in valuations. The new regime trigger a shift away from passive, buy and hold strategies onto active market timing and astute risk management.
BEAR MARKET ROADMAP: 3-STAGE PROCESS, NOT EVENT Historical analogies offer a useful probabilistic guide of the bear roadmap ahead, demonstrating a 3-stage process, not an event. The traditional shape is a fall, rally, then rest of fall. Nevertheless, each bear market exhibits a unique character, with a range of price and time patterns. True to the adage, “history does not repeat”, but “it does rhyme”. The final chart below offers a range of good, bad and ugly scenarios. Presently, the latest market crash is in-line with the 1987 crash, in terms of the short-lived technical pattern, losing 30-40% in only 4-weeks, with the potential of a V-shape recovery. However, our historical models are in strong disagreement with this optimistic view, alternatively favouring a bad, or ugly scenario, exhibiting a blend of either a U or L-shaped pattern (figs 3-6).
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ABOUT ALPHACHAIN In either case, the average bear market signature leads to a 50% price drop, with a time duration ranging from 1.5 to 3 years or so. The ugly exceptions are the 1974 shock and 1929 Crash (figs 5 & 6), with the latter roadmap providing an eerily close historical parallel. The 2020 Crash has already outperformed the early stage of the 1929 Crash in terms of the speed of the fall. What followed was a rebound of 51%, before the completion of the waterfall decline of 86%, punctured by multiple bear-market rallies, which ultimately invigorated the race to the real low.
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Web: https://www.alphachain.academy/ Phone: +44 20 7097 1715 Email: info@alphachain.co.uk Office: 25 Clarendon Road, Redhill, Surrey, RH1 1QZ Disclaimer: Trading in any financial products whether with or without margin carries significant risk and may not be suitable for all investors. We advise you to carefully consider whether trading is appropriate for you based on your personal circumstances. Trading involves risk. Losses can exceed deposits. We recommend that you seek independent advice and ensure you fully understand the risks involved before trading. All information in this publication is for education only and should not be seen as advice or a trading signal.