We’ve talked a lot about oil, the rebound of which has probably led to the trade of the year. If you recall back on February 8th, we said policymakers finally got the wake up call on the systemic threat of the oil price bust when Chesapeake Energy, the second largest oil and gas producer, was rumored to be pursuing bankruptcy.
This is what we said:
“The early signal for the 2007-2008 financial crisis was the bankruptcy of New Century Financial, the second largest subprime mortgage originator. Just a few months prior the company was valued at around $2 billion.
On an eerily similar note, a news report hit this morning that Chesapeake Energy, the second largest producer of natural gas and the 12th largest producer of oil and natural gas liquids in the U.S., had hired counsel to advise the company on restructuring its debt (i.e. bankruptcy). The company denied that they had any plans to pursue bankruptcy and said they continue to aggressively seek to maximize the value for all shareholders. However, the market is now pricing bankruptcy risk over the next five years at 50% (the CDS market).
Still, while the systemic threat looks similar, the environment is very different than it was in 2008. Central banks are already all-in. We know, and they know, where they stand (all-in and willing to do whatever it takes). With QE well underway in Japan and Europe, they have the tools in place to put a floor under oil prices.
In recent weeks, both the heads of the BOJ and the ECB have said, unprompted, that there is “no limit” to what they can buy as part of their asset purchase program. Let’s hope they find buying up dirt-cheap oil and commodities, to neutralize OPEC, an easier solution than trying to respond to a “part two” of the global financial crisis.”
Chesapeake bounced aggressively, nearly 50% in 10 business days.
And on February 22nd, we said, “persistently cheap oil (at these prices) has become the new “too big to fail.” It’s hard to imagine central banks will sit back and watch an OPEC rigged price war put the global economy back into an ugly downward spiral. And time is the worst enemy to those vulnerable first dominos (the energy industry and weak oil producing countries).”
As we’ve discussed, central banks did indeed respond. The BOJ intervened in the currency markets on February 11, and that (not so) coincidently put the bottom in oil and global stocks. China followed on February 29, with a cut on bank reserve requirements, then ECB cut rates and ramped up their QE and the Fed joined the effort by taking two projected rate cuts off of the table (we would argue maybe the most aggressive response in the concerted central bank effort).
From the bottom on February 8th, Chesapeake shares have gone up five-fold, from $1.50 to over $7. Oil bottomed February 11 and is up 77%. This is the trade of the year that everyone should have loved. If you’re wrong, the world gets very ugly and you and everyone have much bigger things to worry about that a bet on oil and/or Chesapeake. If you’re right, and central banks step in to divert another big disaster (a disaster that could kill the patient) you make many multiples of your risk.
We think it was the trade of the year. The trade of the decade, we think is buying Japanese stocks.
Overnight the BOJ made no changes to policy. And the dollar-denominated Nikkei fell over 1,200 points (more than 7%).
As we said yesterday, two explicit tools in the Bank of Japan’s tool box are: 1) a weaker yen, and 2) higher stocks. I say “explicit” because they routinely have said in their minutes that they expect both to contribute heavily to their efforts. So now Japanese stocks and the yen have returned near the levels we saw before the Bank of Japan surprised the world with a second dose of QE back in October of 2014. So their efforts have been undone. And they’ve barely moved the needle on their objective of 2% inflation during the period. In fact, the head of the BOJ, Kuroda, has recently said they are still only “halfway there” on reaching their goals.
So they have a lot of work left. And if we take them at their word, a weak yen and higher stocks will play a big role in that work. That makes today’s knee-jerk retreat in yen-hedged Japanese stocks a gift to buy.
U.S. stocks have well surpassed pre-crisis, record highs. German stocks have well surpassed pre-crisis, record highs. Japanese stocks have a long way to go. In fact, they are less than “halfway there.”
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