<img height="1" width="1" style="display:none" src="https://www.facebook.com/tr?id=905697862838810&amp;ev=PageView&amp;noscript=1">

LenderHub

SWBC's LenderHub blog is a one-stop resource for lenders.

 

They Made a Desert and Called it Peace


desert-600.jpgWhen I begin naming pieces by quoting Tacitus, you know it’s getting bad.  The level of panic in the markets this week felt eerily like 2008. How did we get here so fast?

Last week I spoke of the terrific negative feedback loop the Saudis had created for themselves in their efforts to crush U.S. shale producers. I posited that the Saudis were starting to realize that, at a certain price, they could bring the shale producers to heel and still escape without significantly damaging their investment portfolios and oil customer base. As we saw yesterday, they may have determined that bottom number is around $26 per barrel. Granted, we bounced off that bottom due to a Tweet from a “Mideast OPEC Correspondent” who attributed a statement to the United Arab Emirates that OPEC was ready to cut production. The Tweet pushed crude up $1 from its lows of the day, and the S&P up 20 points in a couple of minutes. This Tweet, like many others before it, turned out to be false. However, the Saudi strategy to overwhelm its U.S. competitors seems to be working. This week, a parade of major U.S. producers slashed capital expenditures, budgets, and dividends; performed desperate debt swap gymnastics or just simply considered filing for bankruptcy. The Saudis are “winning” the battle but they may very well be losing the war.

I say this because a funny thing happened this week as the Saudis attempted to make their way to the end zone. On Tuesday, analysts began focusing on the European banking sector, primarily Deutsche Bank. They suggested that due to the rather sharp drop in operating earnings, and the seemingly never ending blockbuster of regulatory fines, the bank’s observable cash flow may not be sufficient to pay the coupons on its Contingent Convertible bonds (CoCos). As a result, its stock crashed below the lows set during the financial crisis. Soon after, other leading European banks like Credit Suisse and Barclays became suspect as well. Suddenly, another potential crisis was rearing its head and memories of 2008 came to mind. That financial crisis ballooned into a full-blown economic crisis when the global banking system seized up. Domestic economies, “Main Street” if you will, lost access to liquidity and suffered what I have described in the past as a massive heart attack. Banks are leveraged institutions, and when their ability to service their debt becomes suspect, the markets react by increasing the banks funding costs, sharply. The “best” result is a significant hit to the bottom line, which is especially harsh because banks have a relatively high degree of leverage. The “worst” result is that once the market questions a bank’s ability to pay its debt, this potential inability becomes a self-fulfilling prophecy. We are left to ponder systemic risk and “Too Big to Fail” scenarios.

You might be asking, “What does all of this have to do with the Saudis? Are you laying the blame at their feet?” The answer is “Yes I am.” Of course, not all of this is their fault, but a lot of it is. The Saudis embarked on a course to grind rivals into dust by overwhelming the market with supply during the global economic slowdown. They drove prices down to the point where it was unsustainable for anyone else to run their operations. They succeeded, but in doing so, the Saudis have become a huge global deflationary force that has led to negative interest rates throughout the world, especially in Europe. Negative rates play havoc with European bank earnings. Furthermore, the large European banks like Deutsche and Credit Suisse maintain energy loan portfolios and high-yield bond desks that have significant exposure to the companies the Saudis are driving to the wall. Moreover, as emerging markets have significant links to oil, the bank’s exposure to that sector is damaging as well.      

I believe in a rather myopic fashion the Saudis set out to destroy their enemies in oil production and now they have damaged the global banking sector. Not only do I believe the Saudis have significant investments in global bank stocks and bonds and have therefore, hurt themselves, but additionally, if the banking system is compromised, then the global economy, and, therefore, their customer base, is compromised. I am highly confident that no one of any influence in the Kingdom saw this coming but now it may be here. Hence the title, “They made a desert and called it peace.”

Hopefully I am wrong on this one, and maybe this latest turn encourages the Saudis to come to the table. However, I think that this scenario is entirely plausible, and I believe these are the types of factors the Fed is considering as they re-evaluate monetary policy in 2016.

Member SIPC & FINRA. Advisory services offered throughSWBC Investment Company, a Registered Investment Advisor.

- Not for redistribution -

SWBC may from time to time publish content in this blog and/or on this site that has been created by affiliated or unaffiliated contributors. These contributors may include SWBC employees, other financial advisors, third-party authors who are paid a fee by SWBC, or other parties. The content of such posts does not necessarily represent the actual views or opinions of SWBC or any of its officers, directors, or employees. The opinions expressed by guest bloggers and/or blog interviewees are strictly their own and do not necessarily represent those of SWBC. The information provided on this site is for general information only, and SWBC cannot and does not guarantee the accuracy, validity, timeliness or completeness of any information contained on this site.  None of the information on this site, nor any opinion contained in any blog post or other content on this site, constitutes a solicitation or offer by SWBC or its affiliates to buy or sell any securities, futures, options or other financial instruments. Nothing on this site constitutes any investment advice or service. Financial advisory services are provided only to investors who become SWBC clients.

desert-185.jpg

Leave a comment below!