Alchanati Campbell & Associates
Share Buybacks. Share buybacks and dividends have historically been used to distribute earnings back to its shareholders when the board of the company believes they don’t have a better use for the excess cash. To decide between distributing dividends or conducting share buybacks, the company decides whether they believe their shares are undervalued or overvalued, if the former, they conduct buybacks. As of the last 5 years, this has not been the case. Companies have been conducting rampant share buybacks, distributing a majority of retained earnings, further exhausting any potential cash reserves to be used during times of distress. Boards of these companies have been looking out for their own interest, conducting share buybacks, then selling into these now higher share prices with their share options. Since 2013, Boeing decided to buy back over $42b dollars’ worth of equity, while board members and insiders sold over $1.2b. If Boeing had not bought back shares, but instead amassed a cash reserve for times like this, they would not be fearing a bankruptcy and more importantly not asking the government for a bailout. The question to be asked is, why is it the US taxpayers responsibility to bail out these companies when they have never had our interest in mind? Let capitalism run its course, companies will start managing their risk better, without the safety net of knowing the government will bail them out.
Unemployment. In the month of March, non-farm payrolls fell by 700,000. It was the first time since the Financial Crisis that payrolls declined month to month. Unemployment is now up to 4.4%, the highest it's been since 2017.
We've mentioned before that the unemployment rate doesn’t capture a perfect picture of the job market. It doesn't take into account discouraged workers -- people that have simply given up looking for jobs. Also, unemployment numbers underestimate the overall impact because they don’t include people who are self-employed and ineligible for unemployment benefits. When businesses such as retail shut down, other business such as advertising become affected. And, as unemployed individuals cut back on spending, all industries are affected. Furthermore, the data collection period is based on information available the week of March 12th, before the totality of the economic shutdown began to sink in. Combining the lack of new data with the systematic flaws of the unemployment rate and it seems that the situation will only begin to appear direr as the weeks go on. Analysts of the big banks estimate that job losses will hover around 10 million when new information is released in April.
Deflation. One of the big risks that we feel is not getting enough attention is the very real threat of deflation. The opposite of inflation, deflation is the general fall of prices. It generally occurs when people are not spending money (having more goods produced than there is a demand for). I'd wager that bad deflation is more significant than inflation. Think about it. If I knew that the price of something was going to be lower tomorrow, wouldn't I wait until tomorrow to buy it? Or maybe even the next day? The stimulus package should alleviate some of the concern, but truth be told, it will depend on how long the shutdown lasts for. The government can't fund our consumption indefinitely. Well, maybe they could, but it would take some intervention never before seen in our lifetimes.
Brent Oil Index. Generally used as the benchmark for world oil prices, the price of Brent crude oil has maintained its relevance in the world oil market for over three decades. In the international oil trade, a blend of crude oil extracted from the North Sea, between the Nordic countries and Great Britain, has been used to set the price for over 60% of all oil traded on the global market. This specific oil blend was chosen because of its relatively “light” qualities, meaning it contained little sulfur and therefore could be easily refined into high-demand oil products, such as gasoline. Additionally, its source being on the ocean, its production could be increased or decreased with demand, cushioning the price from supply issues and therefore making its price more reflective of global oil demand. A rival claimant to world oil pricing, West Texas Intermediate, or WTI, is priced in Cushing, Oklahoma, and is largely based on American oil production. Unfortunately for WTI, its usefulness as a benchmark is diminished by the fact that Oklahoma is landlocked, meaning it must use pipeline networks to make it to the world market, and therefore can be overwhelmed when demand outstrips those networks.
Oil markets rocked by an international price war. For the past several years, OPEC, or the Organization of Petroleum Exporting Countries, has maintained an economic alliance with the Russian government, where both organizations agreed to decrease production to maximize the global oil price, so as to maintain the profitability of Russian oil projects while stabilizing oil demand to a more sustainable level. However, the COVID-19 outbreak had seriously reduced global oil demand, requiring further production cuts to keep the price stable. On March 8, 2020, the Kingdom of Saudi Arabia launched a price war with the Russian Federation due to a breakdown in negotiations between OPEC and Russia over whether or not to initiate further production cuts in the face of the COVID-19 pandemic, with Russia resisting any more production cuts. By selling their oil at a massive discount to the world price (the Saudis priced their oil at 10$ a barrel), the Saudi government put massive pressure on the Russian government to agree to further production cuts, or risk upending their vitally important oil and gas industry. These actions, in combination with pandemic containment measures that have drastically reduced economic activity, have put the world oil price in freefall, with Brent Crude falling from $54 a barrel on March 4th to $34 on March 9th, and $26 on March 18th. While the pricing feud has played out between the Russian and Saudi governments, the international oil production chain has been thrown into disarray, with massive oil rig closures throughout the world, and billions being wiped from the value of oil giants such as Occidental and Haliburton. The economic pain has been especially present in the Permian Shale basin of West Texas, where a number of heavily indebted oil producers have barely hung on for years, as their methods of extraction are only economical at higher oil prices. The Permian basin has been hugely influential on the international oil markets, helping to make the United States the world’s largest oil-producing country since late 2018. A wave of bankruptcies by oil producers in the region could force many fields offline, substantially reducing world supply, and devastating the economies of oil-producing regions across North America, from West Texas, to Oklahoma, and all the way to North Dakota and Western Canada. Many have speculated that this price war is an indirect way for Russia to wipe out American competition in the oil industry, as the country is especially dependent on oil exports to finance its national budget, and could, in the long run, strengthen the Russian government’s influence over global energy markets, if American producers are allowed to go offline. President Trump has recently announced that he believes that Saudi Arabia and Russia are close to reaching a deal over production cuts, indicating that the US government has intervened in the talks between the oil giants, though an agreement is far from certain between the feuding powers.
Just for a second imagine you are a small business owner. You have fought and worked tirelessly to keep your business alive, on average you worked 20 hours more per week than the average American worker. After 10 long years, your work has paid off and you are part of just 30% of small businesses that make it past 10 years. Something that you have created is part of the other 30 million small businesses that together make up the backbone of the American Economy. But after years of economic growth things have taken a sharp and sudden turn. Not only is the economy heading for a massive recession, but now your business is effectively shut down. In the best-case scenario you are providing some essential product or service and are allowed to stay open at the cost of you and your employees' health, but worst case your business is completely shut down.
To help small business owners face these unprecedented circumstances the Federal Government has approved $376 billion to be used in the “relief for American workers and small businesses”. The Federal Government, in working with the U.S Small Business Administration, has concluded that small businesses will face issues in securing capital, maintaining a workforce/inventory, facility remediation, insurance coverage, market demand, and in general adjustment to the circumstances. To combat these issues the SBA is facilitating the use of the $376 billion through a variety of loans to small business owners, many of which are forgivable. Unfortunately, much like the approved stimulus check, these loans are running into problems. As of today, the Federal loan program for small businesses was supposed to be up and running, but the SBA and the U.S Treasury were still finalizing details that left banks unprepared to handle the flood of applications. The hope is that in the coming weeks the process will be streamlined, and small businesses will get the money they desperately need. Some banks are already approving applicants and as of this afternoon Bank of America alone had granted over 58,000 client loans and received over 22.2 billion in applications.
The Alchanati Campbell and Associates Team
WHAT'S UP FRIDAY? is a weekly newsletter that will give you a summary of "What's up?" on Wall Street, in the US and around the World written by The Alchanati Campbell and Associates Team. What makes us unique is we focus on long-term knowledge; knowledge that will still be useful to you 10 years from now.