Wednesday, November 25, 2015

Chesapeake Energy Haunted by a Bad Deal, Bankruptcy Looms?

  • Shares of Chesapeake Energy have fallen from over $24 in November of 2014 to the present traded value of just above $5 per share.
  • Chesapeake Energy’s senior unsecured debt has also plummeted over 50% in traded value in just the last 6 months.
  • This report analyzes Chesapeake’s financial health and ability to withstand the oil and gas market price collapse.
  • The findings expose critical issues concerning company production results, non-competitive cost structure, expiring derivative positions and royalty owner litigation.
Over the last year the shares of Chesapeake Energy (CHK) have been on a constant spiral downward, falling from over $24 in November of 2014 to the present traded value of just above $5 per share.  The rapid share price decline and volatility has been relentless.  After a brief share rally in early October the shares have dropped 50% in value with bids being hard to find for the stock.

We all know the market prices for oil and gas are very depressed at present, approaching the lows reached in the depths of the 2008 financial crisis.  Chesapeake bottomed at $15 per share in the 2008 market carnage, but now is on a direct line toward $0.  Why is the 2nd largest gas producer in the U.S. having such difficulty coping with the present market circumstances, whereas it survived the 2008 crisis?

Tuesday, October 27, 2015

Scorpio Tankers - Undervalued Gem in an Over-Supplied Oil Market

The business model of almost every oil related business has been tested as the dollar price per barrel has fallen from over $100 in June of 2014 to the present $45 price in October 2015.  As stock prices of energy sector firms have plummeted, many investors are currently playing a nervous game of trying to call the bottom in the hope of catching upside gains in the event the tide turns quickly.

Loading up for an eventual sector rebound may require extreme patience given the level of over-supply in the production pipeline worldwide at the present moment.  The tide will turn, but in the meantime, most investors still want to make money.  And, like most industry sectors, just because a bear market has set in for the near-term, it does not mean that opportunities in the oil market for upside gains and cash returns are not possible – just that they may be a little harder to find.

The current opportunity in the over-supplied oil sector is simple – look for marine based petroleum transport companies like Scorpio Tankers (STNG) which in my opinion is substantially undervalued given the current market dynamics.  Why?

Export driven oil counties like Saudi Arabia, Russian, etc. have flooded the market with crude over the past year and the excess supply has to go somewhere.  Presently the somewhere is primarily China and other Asian emerging market, driven by currency pegs held high relative to the strong dollar and a oil futures curve contango with a favorable low dollar front end price level.  The ancillary beneficiaries of this situation are companies like Scorpio Tankers which specializes in the transportation of oil via tanker ships worldwide.  And, as the current flow of oil into storage becomes saturated and the North American shale oil business model implodes as it is presently doing, the benefits will continue to accrue to shippers like Scorpio because the U.S. will return to greater dependency on imported oil and related petroleum products.

Monday, October 12, 2015

Has Oil Finally Found a Bottom?

Over the past 5 trading days post the Friday morning October 2nd 8:30 jobs report, investors with exposure to the energy sector have been treated to a major rally.  As seen in the graph below, the Energy Select Sector SPDR ETF (XLE) has risen 14.5% from $60.62 at the open on Friday to the closing price of $69.41 on Thursday. 

Compared to the S&P 500 (SPX) (SPY) aggregate index, which has posted a 4.5% gain over the same period, the out performance of the energy sector is substantial, and worth taking a closer look at to understand what is driving the significant divergence in the returns before diving into just any energy stock at this point in time. 

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Wednesday, September 2, 2015

DOW Sends Rare Signal at the August 2015 Month End Close

If you currently have positions in U.S. equities, you might be interested in the rare and usually ominous signal that was sent by the DOW (DIA) and S&P500 (SPY) at the close of trading on August 31st in 2015. 

The DOW closed the month of August at 16,258, 3.3% lower than the close at the end of August in 2014.

Why is this change in the DOW an important signal for investors to pay attention too?  Because year over year monthly changes in the DOW are rare, particularly when the recent occurrence is after an all-time high was set 3 to 4 months earlier.

What information is the DOW Signal Sending?


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Sunday, August 30, 2015

Warning: China propping up their economy by “selling” U.S. Treasuries

"The Fed doesn’t fully understand the market volatility that stemmed from China’s shift in its foreign exchange regime" commented Fischer in a media interview in Jackson Hole, Wyoming.   (See CBS MarketWatch, August 28, 2015)  Even the U.S. Federal Reserve  isn't clear (or willing to share) what is really going on, so investors may want to get the facts for themselves.

The knee jerk reaction in the media that the Chinese were devaluing the Yuan on purpose shows how shallow U.S. reporting on financial markets has become.  The facts are that there is a capital flight out of China that has been putting severe downward pressure on the Yuan.

The Chinese did not “devalue”, which implies they are playing the typical mercantile economic game of manipulating their currency downward against the dollar to improve trade by "buying" U.S. Treasuries.  To the contrary, the Chinese had to "sell" $100B in U.S. Treasuries (See Bloomberg News, August 27, 2015) just to maintain the peg they have set against the U.S. dollar for the Yuan in order to support their own their own declining economy.

What this means to the Fed is that financing the U.S. debt has just reached a tipping point.  What China did by selling $100B U.S. Treasuries will have the same effect as the FED buying Treasuries.  It floods the market with more dollars.  The problem in this instance is that the FED now faces the real possibility that it might be the only buyer left that wants U.S. Treasury paper if this trend continues.  Raising rates is very likely to become the only means the Fed has to support the huge financing appetite of the U.S. government since the supply chain from emerging market mercantile economies like China and petrodollar fixed income supplies from Saudi Arabia are beginning to dry up.

Thursday, August 27, 2015

Financial Relativity Index Warns Investors to Reduce U.S. Equity Exposure

Anyone who follows the Financial Market Vigilante blog and has read my book, Theory of Financial Relativity, knows that my research looks at the U.S. financial markets systematically.  By looking back through time to gain an understanding of how key market metrics performed during boom and bust cycles, I have developed a heuristic model which investors can use to gauge whether key fundamental forces are strong enough to sustain current stock market index price levels.  The model is simple.  It contains 7 market variables that are tracked through time.  As specific market thresholds are breached, the risk of a DOW (DIA) or S&P500 (SPY) market downturn increases.  The model uses quantitative metrics (and one qualitative).

To illustrate the stability in the relative value of the market at any particular time, the index variables (shown in the graph below) are illustrated using green, yellow and red markers.  Green is considered the neutral or low probability zone for the metric to create a condition conducive to a major market correction.  Likewise, a yellow marker denotes a cautionary condition, and red denotes a relative measure that has a high probability of causing downward market pressure.  Through time as the measurements change, the directional change in each variable is also assessed and if a variable is approaching, but not yet reached a warning condition, then it is outlined in red.

At the beginning of 2015 my commentary on the state of the U.S. equity market based on the Financial Relativity Index was the following:

“The financial metrics as 2015 begins are increasingly cautious, as exhibited by the number of yellow and red markers. The model over the past two years has become progressively more “colorful.”, another way of saying the trend is not your friend at the present time. Based on the research I have done in each categorical area, I expect more of the metrics to reach a red level before the stock market is likely to undergo a sustained severe downturn. The increased areas of caution in many of the metrics, however, set 2015 up in my opinion to be a very volatile year for equity values, with a likelihood of a major intra-year drop at some point.”  - Blog Post, January 10, 2015

The metrics referred to in the statement are shown in the table below, and augmented by the status of the metrics as of the end of July, 2015.  The July month end metrics, which were updated on the Financial website after the July close, included a warning statement for the first time.  The warning was “Deflation Driven Correction Risk Extreme”.

The movement in the metrics since year end 2014 led to the need to post the warning.  In particular, the index metrics that have worsened since the first of the year are: 

  1.  GDP / Lending Risk - the continued increase risk in U.S. credit markets as loan balances grow to all-time highs relative to the size of US GDP.
  2.  BAA1 / 30 Year Treasury Spread - a major widening of spreads between the Treasury market and investment grade bonds to historical warning levels.
  3. Fiscal Spending Rate - stagnant U.S. fiscal spending yearly growth continues below historical levels and slowed to -0.1% in Q2 2015.
  4. Oil Price Levels - rapid commodity price deflation as exhibited in the oil market creates a warning sign on what should be a positive for U.S. consumers.
  5. Fed Policy - the tightening of monetary policy relative to the world because other countries are devaluing their currencies relative to the U.S. dollar.
All these metrics became progressively stronger headwinds as the stock market pushed to higher and higher all-time highs during the first half of 2015.  The fact that Apple (AAPL), the bell weather in the current tech driven bull market, suddenly lost its appeal in the market and recently entered correction territory was a good anecdotal signal that the overall market was entering a correction phase.  The stock market relative to GDP (DOW:GDP) has been expensive for over a year, and is now in progress of rolling-over.  The recent market pull-back has left the metric in caution territory, but since the momentum in stock price growth is now negative, risk is still high for further declines.

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Sunday, June 7, 2015

Margin Debt Reaches New All-Time High – Bullish or Bearish?

Money used to margin stocks on the NYSE grew to $507B in April 2015.  (see NYSEData.comFactbook: Securities margin debt)  Looked at in isolation, you might interpret the continued inflow of leverage to buy market assets as a bullish indicator.  Investors are confident in the future, therefore why not take cheap money and buy assets that seemingly just continue to rise.

The temptation to rationalize that margin activity is a positive indicator for stocks is a function of how highly correlated the level of margin debt and the major stock indexes (SPY) (DIA) have been over the past 50 years.  As shown in the graph below, the correlation factor between the NYSE margin debt and the level of the S&P500 is .97, almost a 1 for 1 correlation through time.

Correlation does not imply causation, but if interpreted relative to the situation, the riskiness of the amount of leverage being taken on by the market can be an important indicator.  For example, in both 2000 and 2007, the NYSE also set new all-time margin debt levels as the stock market set new all-time record highs for that point in time.  History shows that these were unsustainable high water marks for the stock market, and the ensuing break-down in stock valuations lead to a death spiral exacerbated by margin calls.

As market leverage continues to move to new highs, will the market continue to grind higher or are we about to experience another breaking point?

Saturday, May 23, 2015

Treasury Rates Up, Stocks Up - Will the Pattern Continue?

Since the U.S. Federal Reserve ceased its quantitative easing program at the end of October 2014, the stock market has been decidedly more volatile, while also in my view, trading in a pattern that is counter intuitive to many investors.  During the QE phase, stocks reacted to the increased market liquidity by catapulting higher, while rates across the board fell.  As rates went down, stocks and asset values in general went up.  The expected inverse relationship of asset values to interest rates held.  The major stock index correlation to the increasing size of the Fed balance sheet is virtually 1 to 1 for the period 2013 through mid 2014.

Take away the Fed supplemental diet of steady doses of new liquidity infusions, and as you might expect, U.S. stock returns have struggled.  However, they have not struggled as much as many investors may have expected.  In fact, just this week in May 2015, the DOW (DIA) and S&P 500 (SPY) traded to new all-time highs.  As new all-time highs have been set in 2015, the number of pundits making their predictions of doom in the market seems to get larger and larger. See article: Stockman: Stocks and bonds will 'crash soon'.

The 2015 contrary pattern of Treasury rates trending higher since a low reached in January and stocks moving to new all-time highs is very interesting.  The more investors worry about the impending doom that the Fed will create by raising short-term rates, or worse drawing down the size of its balance sheet, the more the stock market seems to trade higher.  In fact, as illustrated in the graph below, there is a new pattern to which the market is now trading.

As you can see in the graph, since the beginning of 2015, each stock market interim bottom has corresponded with a short-term bottom in long duration Treasuries.  Each short-term peak has corresponded with a peak in long-term Treasury rates.  The current move up in Treasury long duration rates and corresponding move higher in stock prices has not yet confirmed an interim peak, but my estimate is that the May month end close will likely confirm the next reversal point.