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| The darkness of chaos and uncertainty remains, but the light is beginning to shine bright once again |
Contagion. Try saying that word four or five times. There is a weightiness to it- perhaps somewhat diminished after the 2011 movie of the same name, but still, weighty. Following the spread of the coronavirus to all corners of the globe since the turn of the decade a few short months ago, everyone seems familiar with the name. The spread of a virus from person-to-person through human contact or proximity. There is talk of airborne viruses. Methods for sanitation. Guidelines for cross-contamination avoidance. If there is a silver lining to all this, the world’s population has quickly learned about the seriousness of disease; how to limit risks for catching a disease (wash your hands! Remain socially responsible and physically distant if feeling ill!); and finally, the importance of drug discovery and development for our collective future.
We’ll talk about that importance shortly, but first, let us quickly discuss April. The common theme here is best introduced (or reintroduced, if you’ve read The Ignorant Investor’s March post) by an event that occurred on the afternoon of April 20th, when WTI (oil, NYMEX) made history for all the wrong reasons as prices fell more than -300% on the day, albeit in very thin trade, to close at a -$37 per barrel. This is merely a symptom of a bigger problem: real (negative) economic effects are being magnified, spreading throughout markets- crushing commodities (broad-based, not just energy, mind you!), and moving through equity, credit, and currency markets. In summary, economic contagion is propagating and expanding as quickly as the instigating viral contagion.
---A New Hope for Markets on the Coronavirus Front
Global markets – equity, debt, commodity, and currency alike – currently crave certainty and stability above all else. No need to look further than the VIX to understand this more clearly! The big unknown right here is the effectiveness of global containment – not eradication – of Covid-19. What clearly helped calm markets in the middle of this month were reports that a Chicago hospital saw patients with serious cases of the coronavirus mostly make fast and full recoveries after taking Gilead’s remdesivir (and yes, this is the company and drug The Ignorant Investor personally referred to in January’s post, found under the section “Coronavirus' true effect on the global economy is unclear”). While we all await official clinical trial results, market and investor sentiment was decidedly positive on this initial information. Meanwhile, markets have made incredibly strong gains - demonstrating an incredible amount of resilience - over this last month.
In response to possible economic outcomes, consensus on winners and losers are clearly emerging in terms of both sectors and individual companies in the United States. For example, some biotechnology indexes are now within 10% of all-time highs established in 2015. Quality energy names have gapped higher even as oil prices collapse after careful examination by analysts appear to show that they will be survivors of the current energy crisis. Retail companies with a strong online presence have made strong gains relative to the broader sector as the US economy looks to gradually reopen. And these themes hold true across the entire market with respect to the winners (the strong outperforming and pulling ahead of the weak).
Now, with such solid gains across the board over the past month, some investors are sounding the alarm that the rally has come too far, too fast, shifting the risk/reward again to the downside. The Ignorant Investor tends to generally agree with this assessment - that is, across the entire market - but continues to see compelling stories in specific sectors and names. However, as always (hopefully this is doctrine at this point!) be sure to consult with your investment professionals before making any moves into this volatile market.
Now, with such solid gains across the board over the past month, some investors are sounding the alarm that the rally has come too far, too fast, shifting the risk/reward again to the downside. The Ignorant Investor tends to generally agree with this assessment - that is, across the entire market - but continues to see compelling stories in specific sectors and names. However, as always (hopefully this is doctrine at this point!) be sure to consult with your investment professionals before making any moves into this volatile market.
A Wild Ride on the WTI Express
As discussed in The Ignorant Investor’s March post, oil markets continue to face the unprecedented challenge of massive demand destruction amid worldwide government shutdown measures to contain COVID-19. Prior to the virus, demand and supply for worldwide crude was just about balanced. Thus, the US, OPEC, and Russia have been compelled to come to a common understanding to help stabilize the situation, with OPEC+ agreeing to cut about 10 million barrels per day of production. However, the IEA and other entities believe that actual demand destruction could be in the realm of 20 – 30 million barrels per day, creating a supply overhang that will remain frighteningly unbalanced if current coronavirus containment measures remain in place.
Worldwide storage capacity will expand as companies continue to find ways to squirrel away more oil for higher prices at a later time (most recently, attempting to store crude in idled pipelines), but soon – and very soon – worldwide storage capacity will be breached, forcing producers to stop wells (an expensive process that cannot always be reversed) and bringing some production to a crashing halt. Energy company stock prices have largely baked in this scenario. Indiscriminate selling of energy companies ended the week of March 23rd (as observed by The Ignorant Investor) with quality companies across the spectrum experiencing strong buying interest since that time. The same may be slightly less true with the accompanying service industry.
On April 20th, US crude oil prices briefly fell more than -300% to -$40 per barrel. That’s right! For the first time in history, people were paying others money to take oil off their hands. This was a unique situation demonstrating the dire nature of the coming oil crisis, with markets showing us exactly what happens when physical traders no longer want to accept physical oil: financial traders become desperate to escape their contracts (these contracts are typically transferred to physical traders at the end of contract periods, but on this occasion, demand disappeared as physical storage capacity reached limits). Now, don’t read too much into this since the number of barrels that actually traded at negative prices were relatively few. Consider it rather a harbinger of things to come (Bloomberg has an excellent narrative around the April 20th oil price plunge). And then by Friday, April 24th, prices had temporarily recovered to some extent with US crude oil prices rising more than 50% from intraweek lows, sparking massive short squeeze rallies in specific energy names, before again resuming declines this week. This demonstrates what strange times we now find ourselves in as energy markets face a massive upcoming demand supply imbalance.
Energy markets are incredibly complex
As US oil prices collapsed, many retail investors began trying to get additional exposure to oil price upside. Some invested in a fund that attempted to track oil price movements through futures contracts. Sudden price movements of these underlying contracts once oil moved into negative territory sparked the partial collapse of the USO oil fund, demonstrating how important it is that retail investors steer clear of investment instruments they do not understand (even more so instruments that professionals can game to create steady income streams for themselves). Read comprehensive coverage about the USO drama at MarketWatch.
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| An existing drug may well prove to be as effective a counter to the coronavirus as a new one |
Expanding on our previous discussions, we concluded that economic uncertainty will be greatly reduced once a treatment is in place for the coronavirus. Then, further down the road, a vaccine will see a path to pre-Covid-19 normalcy. Therefore, the current objective of finding a treatment is a prerequisite for avoiding a second wave of coronavirus infections, leading to healthy economic activity and improving business conditions.
Drug development has never been easy, as The Ignorant Investor has discussed in depth before, and is a costly process with no guarantee of success. However, enormous resources are being put into drug development at a scale not seen before. There may be more than 150 treatment and vaccination candidates in or entering clinical development, with a few frontrunners that come from reapplication of existing drugs or drugs that have been in development for similar infections for some time. Politico highlights a number of possible candidates with an elevated potential for leading to effective treatments or vaccinations. Several of the frontrunners have demonstrated high efficacy in testing, with initial clinical results expected by the end of the summer. The Ignorant Investor will simply note high personal interest and belief in several candidates that happen to make this list.
