Oil Price Knock On Effects

[Wfearful_Bgreedy]

https://finance.yahoo.com/news/saudis-plan-big-oil-output-225511711.html

 

BBB Downgrade:

I think this is the biggest news no one is talking about. If oil prices keep going down US Shale operations becomes unprofitable and defaults on debt start occurring. Shale needs at least $46/barrel to break even. Russia and OPEC are going to starve shale out by increasing production simultaneously.

 

Shale Boom or Bust?:

There are a lot of US jobs, cities, and loans depending on the success of shale. When prices of oil drop further there will be a cascade effect starting with the downgrade of BBB shale and oil bonds AKA “investment grade” and forced selling by institutional investors, because pension funds are not allowed to invest below a rating of BBB as per their charter.

 

Source: https://www.ft.com/content/c048d870-6138-11ea-a6cd-df28cc3c6a68

 

Pension Forced Selling = Losses on the Book:

The downgrades will end up hurting underfunded pension funds that are 40% below where they need to be not even accounting for the recent corona virus dip. Teachers, Firefighters, Policemen made less income in exchange for a promise that they would be taken care of. City and muni underfunding will lead to less spending and increased fundraising in the form of higher property taxes which will hurt property values.

 

Source: https://www.wsj.com/articles/the-stealth-pension-mortgage-on-your-house-1533496243

 

No equity in the Mortgage:

Many mortgages have a second mortgage or cash out refinances, so not much cushion if property values go down. So take an early 30+ millennial that had to buy a home at ~1M with 5% down using a FHFA loan. Suddenly they will be servicing 2% of 1M instead of 1% to pay for boomer underfunded pensions (property values and tax percentages vary widely by location). The boomers who bought their homes at 350K find they owe 750K still because of the cash out Refis they did while their property value was increasing in order to pay for their kids 150K archaeology and psychology online degree.

 

https://www.wsj.com/articles/americans-are-taking-cash-out-of-their-homesand-it-is-costing-them-11577529000?reflink=share_mobilewebshare

 

 

 

Your Move Boomer:

It was once the case that near retirement one was allocated 80/20 in stocks/bonds, that has since reversed. They can’t find safety in Treasuries or bonds because yields are so low. Their last asset of value is their property which is starting to look like a liability due to property taxes. Also turns out Millennials don’t want a 5 bedroom mansion with a pool and sauna 40 minutes away from the city. I honestly don’t know how this plays out, probably region dependent.

 

https://www.businessinsider.com/millennials-not-buying-big-houses-mcmansions-real-estate-2019-8

 

 

Help us FED:

FED will respond by lowering interest rates even more and might even try buying other types of assets with printed money such as securities in the same way the Japanese government has. Folks who have no real assets such as property, stocks, or bonds don’t get to participate in the asset inflation produced by the FED leading to a furthering of the divide between FED beneficiaries and non-beneficiaries.

 

https://www.nytimes.com/2020/03/06/business/economy/fed-coronavirus-rate-cut-limited-ammunition.html

 

Psychology:

If you are in or near retirement and your 80/20 allocation in stocks/bonds is taking a volatility hit, your pension agreement is being restructured, medical costs are going up, your 4 bedroom home has one room occupied, your friends are leaving for Arizona, Jim Cramer is telling you to sell, your non-fiduciary financial analyst is telling you to use an S&P index and give them a 1% fee through their preferred broker, what do you do?

[ValueArb]

How long can OPEC and Russia survive lower oil prices?

 

What percentage of corporate debt do US Shale operations comprise?

 

Do you really think total comp for public employees corresponds to their free market value, i.e. that any took less income in exchange for those lucrative pensions?

 

What percentage of homes were purchased for 1M with 5% down? 1/100th of 1%?

 

If millennials don't want to live 40 minutes away from the city who is buying all those homes?

 

Lastly, how can an investor to win the guess the Macro-economics game?

 

Hint: The answer is in the movie War Games.

[Wfearful_Bgreedy]

How long can OPEC and Russia survive lower oil prices?

 

The Russians have an incentive to shut down fracking in the US because a byproduct of fracking is Natural Gas / LNG which competes with Russia’s main export. They are willing to lose more on oil if they can gain on NG via shocks to the system.

 

—————————

What percentage of corporate debt do US Shale operations comprise?

 

Correct me if I’m wrong but I think this impacts all US oil majors not just small time frackers. Per FT:

 

Energy companies account for the bulk of debt in the broader high-yield bond market and comprise 13 per cent of bonds rated triple C, the very bottom tier.

 

https://www.ft.com/content/55f74150-4225-11ea-a047-eae9bd51ceba

 

—————————

 

Do you really think total comp for public employees corresponds to their free market value, i.e. that any took less income in exchange for those lucrative pensions?

 

I don’t think future teachers, fire fighters, and policemen will be dissuaded from applying due to pension underfunding. I do think the consumption habits of millions of people will have to change though to adapt to smaller pension plans.

 

—————————

 

What percentage of homes were purchased for 1M with 5% down? 1/100th of 1%?

 

It looks like as of 2018 non-conventional FHFA made 11% of loans. The down payment can go as low as 3.5%.

 

http://www.mortgagenewsdaily.com/10182019_new_home_sales.asp

 

 

—————————

 

If millennials don't want to live 40 minutes away from the city who is buying all those homes?

 

I would argue in many regions we are already seeing decreased demand and prices reflect that.

 

“ In March, The Journal's Candace Taylor reported that millennials are shunning the large, elaborate houses baby boomers built 15 years ago in Sunbelt states like Florida, Arizona, and the Carolinas. Homes constructed before 2012 are being sold at a hefty price cut — sometimes by nearly half — and owners aren't making a profit.”

 

https://www.businessinsider.com/millennials-not-buying-big-houses-mcmansions-real-estate-2019-8

 

—————————

 

Lastly, how can an investor to win the guess the Macro-economics game?

 

 

You are absolutely right that individual security analysis and price discovery is more likely to get you rich compared to macro analysis. I think of macro as Defense and getting the numerator in risk/reward more accurate. Also when central banks start messing with the market I think the argument that macro is irrelevant to Buffett style value investors starts to diminish.

 

My question to you is should one just ignore macro completely?

 

I think these volatility events create even more opportunities for value investors to do security analysis but even more scrutiny should be applied when doing DCF based on past assumptions. For example with ESG many institutional investors won’t be allowed to invest in Oil and Gas. I would argue that these intangibles should be priced in to your analysis.

[K2SO]

Another one: will the Iranian regime survive the double whammy of coronavirus and an oil price shock?