Energy collapse, earnings and consumer credit cracks

The current oil price creates extreme shareholder destruction with the MSCI World Energy Index losing $1.15trn in market value this year. High yield bonds in the energy sector have seen their option adjusted yield spread to Treasuries widen to the highest levels on record and implied default probabilities are rising fast. But how should investors play the energy sector from here? One way is to buy call options on ETFs tracking the US or European oil and gas industry preferably with expiry during the second half. Another option is to get long-term exposure through single stock but here we recommend opting for only the highest quality names (see table below). The most risky strategy is to buy into those names that have the highest bankruptcy risk when the market rebounds, but here we recommend traders to apply some short-term filter (moving average or the like) to get confirmation during the rebound phase.

This week many Chinese companies will report earnings such as Geely Automobile and Air China, but also outside China interesting names such as Dollarama, Carnival, Walgreens Boots Alliance, CarMax, H&M and Constellation Brands will report earnings hopefully providing a picture of the demand situation in the US and Europe as these geographies are impacted by strict lockdowns due to COVID-19. With Carnival shares down 75% from this year’s peak in January and the trouble regarding many cruises during the last two months related to infected passengers with COVID-19 there will be a lot of focus on Carnival’s earnings. The main question is whether the cruise industry can stage a comeback and survive this serious threat to the industry.

In past couple of weeks we have highlighted many times on our Market Call podcast that investors and traders should watch oil, USD and VIX for guidance on market temperature. We have had focus on credit as well but with central banks stepping in the bleeding has stopped for now, but in other parts of the credit market outside corporate bonds there are now cracks happening. Especially consumer credit in China is weaker as the weaker employment is spilling into repayment ability and is likely an indicator of what is coming for the US and Europe. So we recommend investors to put Mastercard and American Express on their watchlists. In China loans to households have risen by 22% annualised and our worry is that at some point this credit expansion will lead to an abrupt halt like we saw in 2008 in the developed world.