Rough Week Ahead? - Bezek's Daily Briefing

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Includes: CHK, EWZ, FCX, SPY, USO, UUP, UVXY, VXX
by: Ian Bezek

Summary

Middle Eastern disappointment sends oil into a tailspin.

Is Saudi Arabia really going to dump almost a trillion in US assets on the open market?

Rousseff impeachment advances in Brazil. What follows?

Friday was another calm day for the markets, in what summed up an uneventful week. The indices closed lower on the session, but losses were quite mild. And the range was low; volatility (NYSEARCA:VXX) (NYSEARCA:UVXY) has been in free fall lately.

But the serene trading conditions aren't likely to continue this week. We've got plenty of potential sources of turmoil on the near-term horizon. Among them, earnings, oil and geopolitical developments. S&P 500 (NYSEARCA:SPY) futures are down 10 points - half a percent - early in Sunday evening trading.

Oil: A Blow For The Bulls

Crude oil (NYSEARCA:USO) is opening the week sharply lower. The commodity plunged more than 5% in early Sunday trading:

That's an ugly chart now. For technical analysts out there, that's a textbook double top. With the big plunge lower, the chart points toward a big breakdown if bulls can't right the ship quickly.

The dump was driven by the predictable failure of the Doha meeting to reach any agreement.

The Saudi position on the negotiations hardened in recent days. They reached the point of demanding that Iran take a lead role in the proposed freeze. Iran, newly back into the market without being limited by sanctions, has no interest in taking the lion's share of any economic loss from a deal.

In any case, there was no production freeze and crude is trading sharply lower due to it. I'm really curious as to what the people who were buying oil last week were thinking. These producer meetings have been almost universally negative since the infamous November 2014 no deal/plunge that really got the energy panic going.

There're two main scenarios that could play out for oil in the week ahead. The first is probably the more obvious; oil keeps dropping, retesting the $35/barrel level in short order. The technical chart is very bad and sentiment will be dour. It's plausible that buyers abandon the arena and oil dives.

However, given the strength of the recent commodity rally, it's quite possible that dip buyers will step in. The February and March commodity rally has been much different than other ones since late 2014. There's been a ton of buying - fear of missing out has kicked in.

People have watched stocks like Freeport-McMoRan (NYSE:FCX) surge from $4 to $11 or Chesapeake (NYSE:CHK) from $2 to $6 and have started dreaming of huge gains on a return to 2013-level prices. This won't happen, but it could take more than one drop in oil to remind people that commodities are still in a bear market.

Geopolitical Tensions: Saudi Arabia

Saudi Arabia is really in the news. Aside from participating in the oil setback, discussed above, they're also leveling a rather large threat at the United States. The New York Times reported that:

Saudi Arabia has told the Obama administration and members of Congress that it will sell off hundreds of billions of dollars' worth of American assets held by the kingdom if Congress passes a bill that would allow the Saudi government to be held responsible in American courts for any role in the Sept. 11, 2001, attacks.

Specifically, the Saudis are threatening to sell roughly $750 billion in US assets. They claim that this would become necessary were the US to try to prosecute Saudi Arabia for its potential role in the 9/11 attacks.

Given what happened to Iran - a massive and long-running asset freeze - their concerns are probably not entirely without cause. Still, many folks are viewing it as posturing. While $750 billion isn't an unthinkable sum for a market as large and liquid as US government debt, it'd still leave a massive mark.

Interest rates would likely go significantly higher in the interim. Particularly with other big saving nations, such as China, facing problems of their own, there's a good chance of there being a shortage of liquidity willing to absorb such a large sale at market prices.

In the bigger picture, this move would drive a big wedge between Saudi Arabia and the United States. The countries have maintained a long-running economic and defense relationship; the Saudi action, as the threat goes, would destabilize the US debt market and perhaps cause a shock to the US dollar (NYSEARCA:UUP) in the near term.

I don't see it as likely that the US will in fact expose Saudi Arabia to prosecution relating to 9/11, and in any case, the Saudis are probably bluffing. Regardless, it's a bold move that clearly puts the Saudis' cards on the table. They are now openly saying that they are willing to cause collateral economic harm to the US if political decisions go against their interests.

Brazil: What's Next?

On Sunday, Brazil's lower house of Congress voted on whether or not to impeach the corrupt sitting president, Dilma Rousseff. Foreign investors have rushed to celebrate the potential impeachment, sending Brazilian shares (NYSEARCA:EWZ) from 17 to 28 in recent weeks.

As of this writing, the vote appears to be going in favor of impeachment. The knee-jerk reaction will likely be higher for Brazilian stocks; this is the outcome the west has been hoping for. But reality will set in shortly - the country is still junk-rated and is running a huge deficit, has crippling inflation, and a completely morally adrift government.

Sure, it appears Rousseff will be gone. But the VP, Michel Temer, is thought to be corrupt and will quite possibly be impeached later this spring. A judge ordered impeachment proceedings to begin against Mr. Temer earlier this month.

What happens after both the president and VP are kicked out of office? I'm guessing most foreigners rushing into Brazilian stocks don't know what would happen after the VP is also booted from power.

If you're counting on someone from Congress fixing the situation, think again. Take this sharply-worded headline from the LA Times: The politicians voting to impeach Brazil's president are accused of more corruption than she is

The Times notes that:

Of 65 members on the impeachment commission, 37 face charges of corruption or other serious crimes, according to data prepared for the Los Angeles Times by the local organization Transparencia Brasil.

Furthermore:

Of the 513 members of the lower house in Congress, 303 face charges or are being investigated for serious crimes. In the Senate, the same goes for 49 of 81 members.

Moreover, the data do not include any possible repercussions for the newest bombshell in the "Lava Jato," or "Car Wash," federal corruption probe. Brazil's largest construction firm, Odebrecht, announced it would fully cooperate with investigation, and on March 23 the Brazilian Federal Police released a spreadsheet appearing to list payments from the company, whose CEO is currently jailed, to more than 200 politicians.

You read that correctly. Not even taking into account the latest large scandal, more than half of Congress and the Senate are being charged with or investigated for serious crimes.

I say it over and over; Brazil is a failed country. The government is not salvageable. This ends in either a military coup or a massive UN-led commission that roots out everything wrong and entirely topples the existing system ala CICIG in Guatemala. It doesn't matter whether Rousseff or some other corrupt crony is the current figurehead; the government as a whole has been exposed as a sham. Both Brazilians and foreign investors will distrust the country's leaders until its government is entirely rebuilt atop new foundation.

Foreign investors are about to re-learn a painful lesson about what happens to uninformed speculators in frontier countries that don't respect the rule of law. You might want to break out your books on the 1997 Asian contagion for a reminder of what's about to happen.

For the sake of being able to quote myself in the future, let's be clear: the Real will trade beyond 5 to the dollar within 12 months, and the Bovespa index will fall by at least a third.

Disclosure: I am/we are short EWZ, UVXY, CHK.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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