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Markets open in the red as oil slides

Yahoo Finance’s Brian Sozzi and Alexis Christoforous break down the market action with Hercules Investments CEO James McDonald.

Video Transcript

ALEXIS CHRISTOFOROUS: Let's check in with James McDonald of Hercules Investment for his thoughts on this wild ride. James, good to see you.

JAMES MCDONALD: Good morning.

ALEXIS CHRISTOFOROUS: Before we get into equities and that whole kit and caboodle, I've got to talk to you about oil. And what do you make of negative oil prices? First time in history. And are you playing in the oil space at all right now?

JAMES MCDONALD: First, I want to say it's very important people recognize what's happening with oil is coming to other asset classes. The unbelievable deflationary situation that we've been in with this virus crisis-- this is just the beginning. And there have been a lot of speculators that have watched oil come down in the last couple of months. And as it goes to lower and lower legs, they want to buy in. If you just look at the largest oil ETF, USO, just four weeks ago, it was at double the price, which at that point was almost an all-time low.

And it's important to understand that what's happening in this sector is coming to other asset classes as well, particularly equities. And I want this to be a warning for people, that we are in unprecedented times. And it's a very, very dangerous market for people that don't have a short bias.

ALEXIS CHRISTOFOROUS: Having said all of that, are you exposed at all to the energy sector? And if so, in what way?

JAMES MCDONALD: What we're looking at-- eventually things will get better. Eventually things will recover. And there are some extraordinary dividend values in the MLP space.

And we are looking at names that are under liquidation right now. But obviously when there's a liquidation, there is a steep discount. And there are assets that are going to be around 12, 16 months from now that are $0.29, $0.39 on the dollar. We're looking at these MLPs holdings very carefully, looking at these bankruptcy proceedings, looking at these liquidations. We're going to find some great values there-- not directly in oil per se, but definitely in the energy space.

ALEXIS CHRISTOFOROUS: You brought up bankruptcies, which makes me think about the retail sector. Neiman Marcus saying that it is going to be filing for bankruptcy. Late last night, Lord & Taylor said it is now exploring bankruptcy. We have to think we're going to come out of this pandemic with a much smaller retail footprint.

Talk to me about how you see retail right now. And where are the opportunities, James?

JAMES MCDONALD: Well, opportunities-- wow, that's a tough question, Alexis. We're just in the beginning phases. Really, this whole problem with the markets, we see it as in three phases. We see it versus the deleveraging and the defaults from the initial shock. Then we see the potential realization of economic data that's happening now and over the next months.

But then the third phase is going to be the default of consumers and small businesses. And what that means right now for retail is you think things hurt now? Wait till 6, 12 months from now. Things are not going to be good.

We're going to see what we've seen in other crisis situations. We're going to see consolidations. We're going to see innovation. This is a destructive process where only the strong will survive. But we think that there will be many new entrants.

As far as opportunities, right now we've got to stay away from buying any of these equities, because they're headed south.

ALEXIS CHRISTOFOROUS: All right, let's get a quick check of the markets here with Jared Blikre. What have we got, Jared?

JARED BLIKRE: All right, we've got the Dow futures down about 475 points, as you can see, or 2%. S&P 500 down about 1.5%. The NASDAQ futures off about 0.7% off, the least. Again, anything oil-related getting whacked right now.

And we can just take another look at crude prices. This is going to be June, not May, which is going off the board and negative right now, but this is off 26%, just an astounding amount. Even Brent is now trading below $20, and doesn't have exposure to many of the problems-- or idiosyncratic factors we have here, Alexis.

ALEXIS CHRISTOFOROUS: All right, thanks, Jared. And we're going to pause for the opening bell at the New York Stock Exchange.

[BELL RINGING]

New trading day underway on Wall Street. It's going to be an ugly open here, as the equity markets react to this crazy action we're seeing in the oil markets, where oil actually turned negative amidst this pandemic, as the market is now awash with oil. And we simply have no place to store it at the moment. Also treasury yields adding to the slide, as pressure on crude markets intensifies.

We are joined this morning by James McDonald of Hercules Investment. Of course, we've also got Jared Blikre and Brian Sozzi with us, as usual. So James, where do you see the market going from here? Because up until the past couple of days, I'm going to say, there's been this disconnect between the news of the day and how the market was reacting.

JAMES MCDONALD: I've been studying this very closely. And I'm fascinated by the idea of central banks around the world buying securities to keep the markets propped up. Nonetheless, that's going to come much later.

What's going to happen right now is we're going to see the digestion of reality in terms of economic data, both employment, earnings, and every other metric where stock valuations are placed. We're currently around a 21 PE average on the S&P 500. Over 36% of companies that have announced earnings so far have come in under.

We see that it's an imminent decline of at least 30%, just based on pure line pricing. If there was no virus, if there is no catastrophic effect on a suspension of all commerce around the country, we still would come down to these levels, because we were at the tipping point of a long, historic bull market that had to come to an end. A normal retracement from that type of a bull market still gets us back down to the 2,100 level on the S&P 500.

And so what I see coming over the next several weeks and several months, as reality is setting in with the new economic forecasts that are now economic realities-- every forecast that came in was-- did not fully reflect the damage. And then there's the risk of reinfection. There are second waves. And when someone gets sick and gets better, the amount of time that it takes for them to recover doesn't necessarily make them not susceptible to reinfection.

So there are a lot of potentially dire scenarios that only bring down the forward-looking price. I would say, you know, obviously stocks are forward-looking. There's opportunities right now where people can see a recovery ahead. But even those scenarios are starting to look very weak.

BRIAN SOZZI: James, just the plunge in oil prices is absolutely remarkable. Do you think-- what's the read there, just from pure economic standpoint, not just in the US, but also in China? I mean, the Chinese economy in some places has opened back up for business, yet you continue to see this glut in oil.

JAMES MCDONALD: Right, so there's a vacuum for demand. And frankly, that vacuum is not going to go away in the immediate future. But again, this is really what's possible when you have a completely disconnected market in a completely interrupted market. The oil sector is just a picture of what's to come.

I think oil itself, you know, it's a little bit different than equities, in that there's a lot of geopolitical issues going on with oil. But still, it goes back to supply and demand. And there's a demand vacuum. And frankly, with the suspension of the economy, I see similar catastrophic, unprecedented, catastrophic drops in prices coming across a lot of asset classes.

We're studying oil in and that it could be a precedent for a lot of these asset classes, where we're putting capital to work.

JARED BLIKRE: Hey James, last time you were here, you had a pretty aggressive downside target. A lot of people are saying we're going to test the lows. You think-- you thought at least that they were going to be exceeded to the downside. Do you still see this scenario unfolding? If so, what are your targets?

JAMES MCDONALD: That's a great question. It's good to see you again. I envy your job. I wish I could look at data all day.

What we're going to have is we're going to have a repricing based on two factors. The first factor is going to be the initial shock of the virus. And that took out the bull market, right? And when a bull market stops, a bear market begins.

And a bear market onset after a record bull market has to get us back to the 2,100 level on the S&P. And it has to get us back to the 17, 17,500 level of Dow before there was even a virus. Once we factor the virus in, as I said earlier, the initial print on earnings is coming out. About a third of earnings have gone away.

If we think PEO ratios are going to be consistent with the pricing after that initial pullback, that brings us down to Dow 15,000. If we get consumer defaults later in the year, like we will-- we believe will happen here-- obviously, people aren't able to go to work. And some of these introductions of the removal of the lockdown, unfortunately, they may be premature. And if we see reinfection rates, it's going to start all over again.

And if people don't have paychecks, if people don't have income, you know, frankly, the rest of the economy is going to suffer. And if you don't listen to me, but you listen to the experts, like at the Fed-- you know, the Fed president of St. Louis thinks we're going to see 30% unemployment. The Fed president in Minnesota thinks that we're going to see similar dire situations. And this is the reality that we have to face.

And so the target for the Dow has to stay at 15,000. I think at that point, I might see the Fed come in. And if we see global banks coming around and investing trillions and trillions of dollars in equities, then that would hold the market up there. But, you know, at a minimum, 15,000 of the Dow, 18-- excuse me, 1,600, 1,800 on the S&P.

ALEXIS CHRISTOFOROUS: James, these are mind-blowing numbers. And people who are watching this right now may be feeling really scared. What's your advice to them? I mean, I know it's a very individual question. It depends on someone's time horizon.

But are you thinking that given all this turmoil, people should just hold onto cash? Is there anywhere to hide, perhaps outside US equities during this tumultuous time?

JAMES MCDONALD: Right. Well, if you have a manager that understands how to monetize volatility, it's a good thing, right? For example, what we're doing, we're profiting from these declines by buying put options, and then taking advantage of volatility, as we have all year. And we can make money for our clients. If you don't have an advisor and don't have the wherewithal to get an advisor who can monetize volatility, and can make money in the short market, absolutely move to cash. There's no reason to lose money.

This rally that's happened over the last several weeks has got a lot of people confused. We've been trying to educate our investors and our prospects about these retracements that have happened. They happened in 2008. The retracement in 2008 went up to the 50% point from the initial pullback, and then came off 50%.

It happened in '87. It happened in '01. It happened in '74. And it happened in 1929. We're about to see lower lowers. And absolutely move to cash, unless you have an expert that can take advantage of falling prices and volatility like we can.

ALEXIS CHRISTOFOROUS: All right, James McDonald of Hercules Investment, always a pleasure. Thanks so much.

JAMES MCDONALD: Thank you so much.