As you might recall, since I’ve written this daily note starting in January, I’ve focused on a few core themes.
First, central banks are in control. They’ve committed trillions of dollars to manufacture a recovery. They’ve fired arguably every bullet possible (“whatever it takes”). And for everyone’s sake, they can’t afford to see the recovery derail – nor will they. With that, they need stocks higher. They need the housing recovery to continue. They need to maintain the consumer and growing business confidence that they have manufactured through their policies.
A huge contributor to their effort is higher stocks. And higher stocks only come, in this environment, when people aren’t fearing another big shock/ big shoe to drop. The central banks have promised they won’t let it happen. To this point, they’ve made good on their promise through a number of unilateral and coordinated defensive maneuvers along the way (i.e. intervening to quell shock risks).
The second theme: As the central banks have been carefully manufacturing this recovery, the Fed has emerged with the bet that moving away from “emergency policies” could help promote and sustain the recovery. It’s been a tough road on that front. But it has introduced a clear and significant divergence between the Fed’s policy actions and that of Japan, Europe and much of the rest of the world. That creates a major influence on global capital flows. The dollar already benefits as a relative safe parking place for global capital, especially in an uncertain world. Add to that, the expectation of a growing gap between U.S. yields and the rest of the world, and more and more money flows into the dollar… into U.S. assets.
With that in mind, this all fuels a higher dollar and higher U.S. asset prices. And when a dollar-denominated asset begins to move, it’s more likely to attract global speculative capital (because of the dollar benefits).
With that in mind, let’s ignore all of the day to day news, which is mostly dominated by what could be the next big threat, and take an objective look at these charts.
U.S. Stocks
Clearly the trend in stocks since 2009 is higher (like a 45 degree angle). Since that 2009 bottom in stocks, we’ve had about 4 higher closes for every 1 lower close on a quarterly basis. That’s a very strong trend and we’ve just broken out to new highs last quarter (above the white line).
U.S. Dollar
This dollar chart shows the distinct effect of divergent global monetary policy and flows to the dollar. You can see the events annotated in the chart, and the parabolic move in the dollar. Any positive surprises in U.S. economic data as we head into the year end will only drive expectations of a wider policy gap — good for a higher dollar.
Oil
We looked at this breakout in oil last week after the OPEC news. Oil traded just shy of $50 today. That’s 17% higher since September 20th.
Oil trades primarily in dollars. And we have a catalyst for higher oil now that OPEC has said it will make the first production cut in eight years. That makes oil a prime spot for speculative capital (more “fuel” for oil). And as we’ve discussed in recent days, weeks and months… higher oil, given the oil price bust that culminated earlier this year, is good for stocks, and good for the economy.
What’s the anti-dollar trade? Gold. As we discussed yesterday, gold has broken down.
If we keep it simple and think about this major policy divergence, we have plenty of reasons to believe a higher dollar and higher stocks will continue to lead the way.
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Stocks continue to chop around as we head into the big jobs report this week. But the dollar has been a mover today, so has gold.
Let’s take a look at the chart of gold. It has broken down technically.
You can see the longer term downtrend in gold since it topped out in 2011. And we’ve had a corrective bounce this year, which was contained by this descending trendline. And today we broke the trend that describes this bullish technical correction (i.e. the trend continues lower).
A lot of people own gold. And it’s a very emotional trade. Whenever I talk about negative scenarios for gold, the hate mail is sure to follow.
We’ve talked quite a bit about the drivers of the gold trade. I want to revisit that today.
Gold has been a core trade for a lot of people throughout the crisis period. When Lehman failed in 2008, it shook the world, global credit froze, banks were on the verge of collapse, the global economy was on the brink of implosion—people ran into gold. Gold was a fear–of–the–unknown–outcome trade.
Then the global central banks responded with massive backstops, guarantees, and unprecedented QE programs. The world stabilized, but people ran faster into gold. Gold became a hyperinflation–fear trade.
Gold went on a tear from sub–$700 bucks to over $1,900 following the onset of global QE (led by the Fed).
Gold ran up as high as 182%. That was pricing in 41% annualized inflation at one point (as a dollar for dollar hedge). Of course, inflation didn’t comply.
Still eight years after the Fed’s first round of QE (and massive global responses), we have just 13% cumulative inflation over the period.
So the gold bugs overshot in a big way. We’ve looked at this next chart a few times over the past several months. This tells the story on why inflation hasn’t met the expectations of the “run-away inflation” theorists.
This chart above is the velocity of money. This is the rate at which money circulates through the economy. And you can see to the far right of the chart, it hasn’t been fast. In fact, it’s at historic lows. Banks used cheap/free money from the Fed to recapitalize, not to lend. Borrowers had no appetite to borrow, because they were scarred by unemployment and overindebtedness. Bottom line: we get inflation when people are confident about their financial future, jobs, earning potential…and competing for things, buying today, thinking prices might be higher, or the widget might be gone tomorrow. It’s been the opposite for the past eight years.
When this reality of low-to-no inflation and global economic malaise became clear, even after rounds of Fed QE, there were a LOT of irresponsible people continuing to tout gold as an important place in everyone’s portfolio, even at stratospheric levels. People bought gold at $1900 and have since lost as much as 40% on the value of their investment – an investment that was supposed to “hedge” against inflation.
On that note, today the IMF downgraded U.S. growth estimates for the year from 2.2% to just 1.6% — in a year that many were initially expecting to be a good year, nearing trend growth levels (3%-3.5%). So eight years from the inception of the Fed’s extraordinary policies, the case for gold remains weak and an investment with more risk than reward.
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Oil popped over $3 from the lows of the day (as much as 7%) on news OPEC has agreed to a production cut.
We’ve talked a lot throughout the year about the price of oil. When it collapsed to the $20s, it put the entire energy industry on bankruptcy watch.
Of course, oil bounced sharply from those lows of February as central banks stepped in with a coordinated response to stabilize confidence. Not so coincidentally, oil bottomed the same day the Bank of Japan intervened in the currency markets.
The oil price bust all started back in November of 2014, the evening of Thanksgiving Day, when OPEC pulled the rug out from under the oil market by vowing not to make production cuts, in an attempt to crush the nascent shale industry. At that time, oil was trading around $73.
You can see in this chart, it never saw that price again.
OPEC was successful in heavily damaging the U.S. shale industry through low oil prices, but it has damaged OPEC countries, too.
What will the news of an agreement on a production cut mean?
A policy shift from OPEC can be very powerful. In 1986, the mere hint of an OPEC policy move sent oil up 50% in just 24 hours. And as we discussed earlier in the year, the relationship between the price of oil and stocks this year has been tight. At times, stocks have traded almost tick for tick with oil.
Take a look at this chart.
An oil price back in the $60s would be a catalyst for a big run in stocks into the year end. For a stock market that has been rudderless surrounding a confused Fed and an important election, this oil news could kick it into gear.
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We have two big central bank meetings this week–BOJ and the Fed. With that, as we head into the week, let’s look at a key chart.
This chart is from a St. Louis Fed blog post last year. The inflation data, however, is all up-to-date. The Fed says “the chart above shows eight series that receive a lot of attention in the context of policy.”
So according to this chart, last year, as the Fed was building into its first rate hike to move away from emergency level rates and policies, the inflation data was looking soft. The Fed was telegraphing, clearly, a September hike, though six of the eight inflation measures in the chart above were running south of their target of 2% in the middle of last year. The headline inflation number for September, their preferred date of a hike, was zero!
Of course, after markets went haywire following China’s currency devaluation in August of last year, the Fed balked and stood pat. When things calmed, in December, they made their move. And at the same meeting, they projected to hike FOUR times this year. So far it hasn’t happened. It’s been a one and done.
Moreover, as of March of this year, they took two of those projected hikes off the table, and guided lower on growth, lower on inflation and a lower rate trajectory into the future. I would argue removing two hikes from guidance was effectively easing.
But if we look at the chart above, where inflation stands now relative to the middle of last year, when they were all “bulled-up” on rates, the story doesn’t jive. By all of the inflation measures, the economy is clearly running hotter (a relative term). Five of the eight inflation measures are running ABOVE the Fed’s 2% target (the horizontal black line in the chart). Yet, aside from a few Fed hawks that have been out trying to build expectations for a rate move soon, on balance, the messaging from the Fed has been mixed at best, if not dovish.
The Bernanke-led Fed relied heavily on communication (i.e. massaging sentiment and perception) to orchestrate the recovery, but the Fed, under Yellen, has been a communications disaster.
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As we headed into the holiday weekend, stocks were sitting near record highs, yields were hanging around near record lows, and oil had been sinking back toward the danger zone (which is sub $40).
In examining the relationship of those three markets, each has a way of influencing the outcome and direction of the others.
First, the negative scenarios: A continued slide in oil would soon sink stocks again, and send yields (the interest rate outlook) falling farther. Cheap oil, in this environment, has dire implications for the energy business, which has a cascading effect, starting with banks, which effects credit and the dominos fall from there.
What about stocks? When stocks are falling, in this environment, it’s self-reinforcing. Lower stocks, equals souring sentiment, equals lower stocks.
What about yields? As we’ve seen, lower yields are supposed to promote spending and borrowing. But, in this environment, it comes with trepidation. Lower yields, especially when much of the world’s government bond markets are in negative yield territory, is having a stifling effect on economic activity, as many see it as a signal of another recession coming, or worse.
Now, for the positive scenarios. Most likely, they all come with intervention. That shouldn’t be surprising.
We’ve already seen the kitchen sink thrown at the stock market. From a monetary policy standpoint, the persistent Fed jockeying through much of the past seven years has now been handed over to Japan and Europe. QE in Europe and Japan continues to promote stability, which incentivizes the flow of capital into stocks (the only liquid alternative for return in a zero and negative interest rate world).
And we’ve seen them influence oil prices as well, through easing, currency market intervention, and likely the covert buying of oil back in February/March of this year (through China, ETFs via the BOJ or an intermediary Japanese bank). Still, OPEC still swings the big ax in the oil market, and it’s been OPEC intervention that has rigged oil prices to cheap levels, and it looks increasingly likely that they will send oil prices higher through a policy move. The news that Russian and Saudi Arabian might coordinate to promote higher oil prices, sent crude 5% higher on Monday.
As for yields, this is where the Fed is having a tough time. They want yields to slowly climb, to slowly follow their policy guidance. But the world hasn’t been buying it. When they hiked for the first time in December, the U.S. 10 year yield went from 2.25%, to 2.30% (for a cup of coffee) and has since printed new record lows and continues to hang closer to those levels than not (at 1.53% today). Lower yields makes it even harder for them to hike because it’s in the face of weaker sentiment.
Last week, we looked at the U.S. 10 year yield. It was trading in this ever narrowing wedge, looking like a big break was coming, one way or the other, following the jobs report on Friday. It looks like we may have seen the break today (lower), following the week ISM data this morning.
What could swing it all in the positive direction? Fiscal intervention.
As we discussed on Friday, the G20 met over the weekend. With world government leaders all in the same room, we know the geopolitical tensions have been rising, relationships have been dividing, but first and foremost priority for everyone at the table, is the economy.
Even those opportunistically posturing for influence and power (i.e. Russia, China), without a stable and recovery global economy, the political and domestic economic outlook is bleak. So we thought heading into the G20 that we could get some broader calls for government spending stimulus was in order.
The G20 statement did indeed focus heavily on the economy. They said, “Our growth must be shored up by well-designed and coordinated policies. We are determined to use all policy tools – monetary, fiscal and structural – individually and collectively to achieve our goal of strong, sustainable, balanced and inclusive growth. Monetary policy will continue to support economic activity and ensure price stability, consistent with central banks’ mandates, but monetary policy alone cannot lead to balanced growth. Underscoring the essential role of structural reforms, we emphasize that our fiscal strategies are equally important to supporting our common growth objectives.”
Keep an ear open for some foreshadowing out of Europe to promote fiscal stimulus – the spot it’s most needed. That would be a huge catalyst for “risk assets” (i.e. commodities, stocks, foreign currencies) and would probably finally signal the top in the bond market.
After a fairly quiet August, we have a full docket of central meetings in the weeks ahead, starting this week. The European Central Bank meets on Thursday.
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Yesterday we talked about the bullish technical breakout shaping up in stocks. Today we want to talk about a very quiet bull market going on that supports the story for stocks. It’s commodities.
Within the course of the past four short months, commodities have gone being the leading threat for global stocks, to being a leading indicator of an emerging bull cycle for stocks.
Oil, of course, was the key culprit earlier in the year. At $26 oil the world was a scary place. The dominoes were lining up for widespread bankruptcies, starting in the energy complex and spreading to financials, sovereigns, etc.
If you recall, back in early February we said in our daily notes, “OPEC is not just in a price war with U.S. shale producers, but it’s playing a game of chicken with the global economy. We’ve had plenty of events over the past seven years that have shaken confidence and have given markets a shakeup – European sovereign debt, Greece potentially leaving the euro, among them. In Europe, we clearly saw the solution. It was intervention. Oil prices are creating every bit as big a threat as Europe was, we expect intervention to be the solution this time as well.”
Indeed, central banks stepped in and removed the risk with a slew of intervention tactics ranging from more QE from Europe, currency intervention from Japan, relaxing reserve requirements in China, to the Fed removing the prospects of two (of what was projected to be four) rate hikes this year.
That was the dead bottom in oil (which started with BOJ action in USDJPY). And it kicked broader commodities into gear, many of which had already bottomed weeks prior. No surprise, commodity stocks have been among the best performing stocks in the world for the past four months.
Now we have oil closing above $50 today, for the first time since July of last year. And remember, two of the best oil traders of all time have been calling for oil to trade between $80 and $100 by next year (both Pierre Andurand and Andy Hall).
We looked at this chart in our April 12th piece and said: “technically, oil looks like a technical breakout is here. In the above chart, you can see oil breaking above the high of March 22 (which was $41.90). In fact, we get a close above that level — technically bullish. And we also now have a technically bullish pattern (an impulsive C–wave of an Elliott Wave structure) that projects a move to $51.50, which happens to be right about where this big trendline comes in.”
You can see we’ve not only hit this trendline and gotten very close to that projection from April, but (not as easy to see in this chart) we have a clear break of this downtrend now. That line now comes in at $49.39. Oil last traded $50.49.
Next is a look at broader commodities. But first, we want to revisit the clues we were getting from commodities back in early March. Here’s what we said in our March 3rd note: “There are other very compelling signs that the global economy is not only backing away from the edge but maybe turning the corner.
It’s all being led by metals prices. Copper is often an early indicator of economic cycles. People love to say copper has ‘has a Ph.D. in economics’ because it tends to top early at economic peaks and bottom early at economic troughs. Copper bottomed on January 15 and is up 13% since.
The value of iron ore, another key industrial metal, has been destroyed in the past five years – down 80%. That metal bottomed quietly in December and is up 32% since.”
The Goldman Sachs commodity index is now up 44% from the bottom, though it’s heavily weighted energy. The more diversified CRB index is up 24%. Both would fall into the bull market category for those that like to define bull and bear markets. But bottom line, when you look at the above chart you can see how deeply depressed commodities have been. The trend is broken, and the model signals for big trend followers are flashing all over the place to be long. And as we said yesterday, in early stages of cyclical bull trends in stocks, energy does the best by far. With that, although the energy sector weathered a life threatening storm, the upside remains very big for the survivors.
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We talked last week about the employment data. It was broadly thought to be disappointing. Even though the headline unemployment rate dropped to 4.7%, the job creation number was weak.
So stocks fell sharply following Friday’s numbers. The dollar fell. And Treasuries rose (yields lower). All of this immediately priced in a gloomier outlook and a Fed that would hold off on a June rate hike.
But remember we discussed how market professionals are trained to hyper-focus on the jobs numbers, even though the jobs numbers are far less important than they are in “normal” times. And with that, we said “it’s probably a good idea to use those moves as opportunities to enter at better levels (i.e. buy stocks, buy the dollar, sell Treasuries).”
That’s played out fairly well today, at least for stocks (the dollar is mixed, yields are quiet). Stocks have recovered and surpassed the pre-employment data levels of Friday morning. Small cap stocks are now trading to the highest levels of the year.
Remember, in the past two weeks we’ve talked about the similarities in stocks to 2010. Through the first half of this year, we’ve had the macro clouds of China and an oil price bust that shook market and economic confidence. Back in 2010, it was Greece and a massive oil spill in the Gulf of Mexico. When the macro clouds lifted in 2010, the Russell 2000 went on a tear from down 7% to finish up 27% for the year. This time around, the Russell has already bounced back from down 17% to up 4%. And technically, it looks like stocks could just be breaking out.
You can see the long term trend dating back to 2009 is still intact following the correction earlier this year. And the trendline that describes the correction has now broken.
As for broader stocks (the S&P 500), the chart looks intriguing too.
Similarly, the trend off of the bottom in the S&P 500 is clear, and a breakout toward new highs looks like it is upon us. New highs in stocks would get a LOT of money off of the sidelines.
With all of the above said, Yellen had a chance to respond to the Friday jobs number today, through a prepared speech for the World Affairs Council of Philadelphia. She downplayed the Friday numbers, highlighted the passing of global risks from earlier in the year, but she did note the Brexit risk (the coming UK vote on leaving/staying in the EU).
With that, perhaps they will use the market sentiment adjustment from the jobs data to their advantage, to justify passing on a June hike in favor of July.
That would give them a chance to see the outcome of the UK vote, and perhaps give them a chance to hike into positive momentum created by another round of stimulus from the BOJ (a possibility next week). Waiting another month is a low risk move. But again, we think the UK leaving the EU can’t happen/won’t happen – maybe down the road, but not now. Despite the popular polling reports, the experts are assigning a low probability. Plus, there has already been clear political messaging attempting to influence the outcome, and we expect that will increase dramatically as the vote approaches (June 23).
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In the middle of June we have perhaps the two biggest events of the year. On June 15 the Fed will decide on rates. And hours later, that Wednesday night, the Bank of Japan will follow with its decision on policy.
This is really the perfect scenario for the Fed. The biggest impediment in its hiking cycle/”rate normalization process” is instability in global financial markets. Market reactions can lead to damage to consumer sentiment, capital flight and tightening in credit—all the things that can spawn the threat of a global economic shock, which can derail global recovery. Clearly, they are very sensitive to that. On that note, the Brexit risk, while a hot topic in the news, is priced by experts as a low probability.
So, the Fed has been setting expectations that a second hike in its tightening cycle could be coming this month. But the market isn’t listening. The market is pricing in just a 23% chance of a hike in June. But as we’ve said, markets can get it wrong, sometimes very wrong. We think they have it wrong this time. We think there is a much better chance. Why? Because they know the BOJ is right behind them. If they do hike, any knee jerk hit to financial markets can be quelled by more easing from the BOJ.
Remember, as we’ve discussed quite a bit in our daily notes, central banks remain in control. The recovery was paid for by a highly concerted effort by the world’s top economic powers and central banks. And despite the perceived hostility over currency manipulation, the powers of the world understand that the U.S. is leading the way out of recovery, and that Europe and Japan are critical pieces in the global recovery. The ECB and BOJ have been passed the QE torch from the Fed to both fuel recovery and promote global economic stability. And playing a major role in that effort is a weaker euro and a weaker yen.
The Bank of Japan is operating with one target in mind, create inflation. Now three years into their massive program, they haven’t posted a positive monthly inflation number since December. Inflation is still dead, just as it has been for the past two decades. So, not only do they have the appetite and global support to do more, but the data more than justifies more action.
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As we’ve discussed over the past few months, markets can be wrong—sometimes very wrong.
On that note, consider that the yield on the U.S. ten–year Treasury was trading closer to 2.30% after the Fed’s first rate hike last December—the first hike in nearly ten years and the symbolic move away from the emergency zero interest rate policy. The ten–year yield has, incredulously, traded as low as 1.53% since. One end of that spectrum is wrong, very wrong.
Remember, as we headed into the last Fed meeting, the ten–year yield was trading just shy of 2% (after a wild ride down from the December hike date). And the communication to that point from the Fed was to expect FOUR rate hikes in 2016.
Of course, in the face of another global economic crisis threat, which was driven by the oil price bust, the Fed did their part and backed off of that forecast—taking two of those hikes off of the table. Still, yields under 2% with even two hikes projected seemed mispriced.
So following a dramatic 85% bounce in oil prices and the threat of cheap oil now behind us (seemingly), as of yesterday afternoon yields still stood around just 1.79%. That’s more than a 1/2 percentage point lower than the levels immediately following the December hike. And that’s AFTER two voting Fed members just said on Tuesday that they should go two or threetimes this year. So with global risks abating, the Fed is beginning to walk back up expectations for Fed hikes.
Confirming that, as of yesterday afternoon, the minutes from the most recent Fed meeting have been disclosed, which now indicate that a June hike is likely assuming things continue along the current path (i.e. no global shock risks emerge).
Still, the yield on the ten–year Treasury is just 1.84%, 5 basis points higher than it was yesterday morning, prior to the Fed minutes.
Why?
The bet is that the Fed is making a mistake raising rates (at all). But at these levels for the ten–year yield, it’s a very asymmetric bet. The downside for yields here is very limited (short of a global apocalypse), the upside is very big. That makes betting on lower yields a very dangerous one, if not a dumb one. When people are positioned the wrong way in asymmetric trades, the adverse moves tend to be violent. I wouldn’t be surprised to see 2.50% on the U.S. ten–year Treasury by the year end.
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In our Billionaire’s Portfolio we followed the number one performing hedge fund on the planet into a stock that has the potential to triple by the end of the month.
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We want you on board. To find out the name of this hedge fund, the stock we followed them into, and the catalyst that could cause the stock to triple by the end of the month, click here and join us in our Billionaires Portfolio.
We make investing easy. We follow the guys with the power and the influence to control their own destiny – and a record of unmatchable success. And you come along for the ride.
Yesterday, SandRidge Energy was yet another energy company to file for bankruptcy this year. Many hear bankruptcy news and think of failed companies. But in plenty of cases, it’s more about opportunism than it is about desperate last acts.
Before we talk about the SandRidge story, we want to give some bigger picture context.
As we discussed a few months ago, the oil price bust, while many thought would be a positive for the economy, because it puts a few bucks in the pockets of consumers, has actually been a huge net negative, because it has brought the energy industry to its knees.
If oil stayed at $26, the shale industry in the America would be done. All of the associated businesses (transportation, logistics, refining, housing, marketing, etc.) – done. Hundreds of thousands of jobs were lost already, and probably millions would have followed. Guess who lends money to the energy sector? Banks. The financial system would once again have been in widespread crisis.
Oil producing countries like Venezuela and Russia would have defaulted. When a biggie like Russia goes, it has systemic ramifications. That event would have likely pulled the leg out from under the teetering European debt crisis chair. From there, Greece would have gone, and Italy and Spain would have probably defaulted. The European Monetary Union would have then finally succumbed to the unmanageable weight of the crisis.
To sum up, cheap oil would have been far worse than the sub-prime crisis. And this time, central banks and governments would have had no ammunition to fight it.
But, central banks stepped in to remove the “cheap oil” risk. The Bank of Japan intervened in the currency markets, and oil bottomed that day. China followed by ramping up bank lending. And Chinese institutions have been big buyers of commodities since. Then the ECB rolled out bigger and bolder QE. And the Fed removed two projected rate hikes from the table. All of this coordinated to directly or indirectly put a floor under oil. Today, oil is up 85% from levels of just three months ago.
So this begs the question: Why is an energy company like SandRidge, a company that has been surviving through the decline in oil prices, cutting production/cutting jobs, now filing bankruptcy? This is AFTER oil has bounced 85% and oil supply has just swung from a surplus to a deficit. And some of the best oil traders in the world are projecting oil prices back around $80 by the end of the year. Why would they throw in the towel now and not in February?
Back in February, SandRidge management missed a debt payment, opting to exercise a 30-day grace period. It was at that stage that the ultimate negotiation should have come with debt holders. Option 1): Restructure debt and perhaps dilute current shareholders by offering debt holders common shares. That gives the company time to ride out the storm of the oil price bust. And it gives all stakeholders a chance to see much better days. Option 2): Close the doors and liquidate assets, and creditors get cents on the dollar.
Instead, SandRidge management and directors negotiated more runway so that they could get to Option 3): the homerun lottery ticket.
In this option, oil prices recover and the company can begin producing profitably again, and brighter days are ahead. But if they rush to file Chapter 11 bankruptcy, while the business fundamentals remain depressed, they can win big. By swapping new stock for debt, the company gets freed of the noose of debt, and the debt holders exchange a piece of paper that was once worth pennies on the dollar, for common stock in a super-charged debt-free company.
That sounds like a win-win. The company continues to operate as normal. Management and the board keep their jobs (and likely their golden parachutes). And former debt holders can make a lot of money.
Who pays the price? Shareholders (the owners). Old shareholders of SandRidge stock have no say in the collusion between SandRidge leadership and creditors. So the owners of the company have their interests effectively stolen by a backroom deal and given to debt holders. And within the bankruptcy laws of Chapter 11, shareholders have no leverage. But who are some of the biggest and most effected shareholders? Employees.
SandRidge has over 1,000 employees. Let’s assume that, like many publicly traded companies, employees of SandRidge have been incentivized to buy company stock as part of their 401k plan (common practice). They have already seen their stock go from $80 to pennies. But now, as an insult to injury, they will continue working to enrich new shareholders while their board of directors have chosen to wipe out their interests.
And sadly, the common stock of companies like SandRidge (which was one of the most shorted stocks on the NYSE) are often shorted heavily by those that own the debt, in efforts to drive the company into Chapter 11, so that they can orchestrate precisely what’s happening today. The stock price gets cheap, then delisted from a major exchange, then credit ratings get downgraded, then banks cut credit lines, and voila, the company find itself in a liquidity crunch and turns to restructurings.
A huge factor in this “homerun option” for the board and creditors is for the company to continue operating as normal. If employees in this Chapter 11 situation would strike, maybe shareholders could have a seat at the negotiating table when these “pre-arranged” reorganization deals are cut. Still, that’s the leverage they hold to derail such a deal.
Consider this: In the depths of the real estate bust, billionaire activist investor Bill Ackman stepped in and bought beaten down shares of General Growth Properties, a company in bankruptcy because it couldn’t access credit. The company had strong assets and strong cash flow (as does SandRidge), but was dependent on a functioning credit market, which was broken at the time. As the largest shareholder, he battled in the board room for the shareholder. He helped management access liquidity and he convinced all stake holders that keeping equity holders intact would result in the biggest outcome for everyone. He was right, and when the credit markets recovered, GGP shares went from 20 cents to over $20 a share.
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