Beware of Wall Street’s “Magical Thinking”

This past weekend, I was reading Peter Pan to my grandsons via video Skype, when I got to Peter’s explanation of how to fly: “You just think lovely wonderful thoughts and they lift you up in the air!”

It suddenly made me think of Wall Street. People who know better are trying to lift up the financial markets with lovely wonderful thoughts. It won’t fly.

Expecting a quick return to normalcy is “magical thinking.” No amount of happy talk can stop the coronavirus from wreaking havoc.

Back in February, influential voices were insisting that the coronavirus was contained and investors should buy stocks on the dips. These optimists were living in fantasyland.

Don’t get me wrong. The news isn’t all bad. Below is a clear-eyed assessment of the positives and negatives. I also steer you toward a source of investment profits. Despite the coronavirus crisis, you can still make money in this market. But you must first dispense with delusions.

Oil prices make history…

Stocks lost ground last week, as the collapse of crude unnerved investors. The West Texas Intermediate (WTI) May oil futures contract price fell into negative territory before expiring. Never in history have oil prices fallen below $0.

We’re likely to see additional pullbacks in the stock market, due to virus-afflicted economic and earnings data.

Countries in Asia and Europe have seen the worst of the outbreak and they’re making tentative moves to reopen parts of their economies. China’s industrial city of Wuhan, where the virus is thought to have originated, is slowly getting back up to speed.

However, the U.S. still grapples with a health crisis of staggering proportions, combined with unemployment levels not seen since the Great Depression. Bullish assertions that the economy will soon turn the corner are unfounded.

The optimists also choose to ignore record-high global debt. We could be facing a European sovereign debt crisis and a cascade of debt defaults in emerging markets. China’s massive credit bubble could burst as well.

Read This Story: The Global Debt Bomb: Tick…Tick…Tick

Social distancing has helped flatten the curve of infections in places such as New York City, but new hot spots are likely to emerge, especially in the South where pandemic precautions were adopted late. The global death toll of COVID-19 currently exceeds 200,000 and a second wave of even deadlier infections is a possibility.

To be sure, it’s encouraging that bond markets have stabilized, with the 10-year Treasury yield hovering at 0.60%. That’s largely due to the Federal Reserve’s aggressive bond-buying programs geared toward shoring up the economy and financial system. But I’m not expecting a miraculous bounce back in the economy. Neither should you.

Think a vaccine will come along like a magic wand to make our woes disappear? According to medical experts, a COVID-19 vaccine might not even be feasible.

Earnings take center stage…

About one-third of the companies in the S&P 500 are scheduled to report first-quarter operating results this week. Keep a close eye on large-cap technology stocks. A handful of Silicon Valley stalwarts have risen sharply off their March lows. If these tech leaders disappoint on earnings, the broader market would likely tumble because it would portend future trouble for the wider economy.

Read This Story: Don’t Bet on a “V” Shaped Recovery

Analysts surveyed by FactSet (the data provider for Investing Daily) currently forecast a 2.9% contraction in U.S. gross domestic product (GDP) in 2020, sharply down from the 1.8% expansion predicted at the end of February.

The eurozone economy is expected to shrink by 4.8% in 2020 while the UK is projected to see its economy contract by 4.9%. China’s GDP is expected to grow by just 2.2%, the country’s slowest GDP growth since modern records began in 1976 (see the chart):

In its latest World Economic Outlook, released on April 6, the International Monetary Fund (IMF) predicted that global economic GDP will contract by 3.0% in 2020. The IMF warned that the world faces a downturn worse than the Great Recession of 2007-2009.

The good news is that analysts expect robust global recoveries in 2021. But in the meantime, economic contraction is accelerating. A major victim has been the energy sector, with oil prices collapsing and oil producing nations thrown into disarray.

Research firm Rystad Energy predicts hundreds of bankruptcies in the U.S. energy sector by the end of 2021 if WTI prices average $20/bbl, a level at which most oil wells are uneconomic. WTI currently hovers at $17/bbl. Hardship in the energy sector will continue causing collateral damage in the wider financial markets.

OPEC leader Saudi Arabia and its on-again, off-again partner Russia agreed on April 12 to cease their oil price war and slash 9.7 million barrels per day in crude production. However, as I wrote at the time, the deal won’t make a meaningful dent in the global oil glut.

Read This Story: OPEC’s Oil Cut: Big Deal or Big Dud?

The production cut agreement doesn’t take effect until May 1. Until then, the spigots are wide open and producers are pumping like crazy. Since the deal was struck, the Saudis have been loading an average of 10 million barrels per day (bpd) onto tankers, about 2.5 million/bpd more than normal. The production cut deal is cosmetic at best, disingenuous at worst. Its main purpose was to reassure energy investors, but it had the opposite effect.

At least one industry is benefiting from energy demand destruction: tanker transport. As land-based storage tanks burst at the seams with excess oil, producers are chartering supertankers at exorbitant rates to anchor offshore and serve as floating repositories of crude. Strange days, indeed.

Editor’s Note: Does the stock market have you spooked? I wouldn’t blame you if you were nervous. But I would blame you if you ran for the exits. Despite all of the uncertainty we’re witnessing these days, there still exist plenty of opportunities to make outsized profits.

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John Persinos is the editorial director of Investing Daily. Send your questions and feedback to: mailbag@investingdaily.com