JPMorgan’s contingent interest autocallables linked to Occidental Petroleum offer value play

By Emma Trincal

New York, Oct. 11 – JPMorgan Chase Financial Co. LLC’s autocallable contingent interest notes due Jan. 14, 2021 linked to the common stock of Occidental Petroleum Corp. offer a good entry point, maximizing the odds of getting the double-digit coupon via an unpopular trade, said a contrarian portfolio manager.

“This is a pretty reasonable investment that gives investors a very high percentage chance of success,” said Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments.

“The stock is unloved, as most oil stocks are at the moment. And that’s a good thing.”

Each quarter, the notes will pay a contingent coupon if the stock closes at or above the trigger level, 60% of its initial share price, on the review date for that quarter. The contingent interest rate is expected to be at least 11.5% per year and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par if the stock closes at or above its initial share price on April 9, 2020, July 9, 2020 or Oct. 9, 2020.

The payout at maturity will be par unless the stock closes below the trigger level during the life of the notes and finishes below its initial price, in which case investors will be exposed to the stock’s decline.

Bottom level

The first positive aspect of the deal was the low share price of Occidental Petroleum.

“The stock is at its lowest since November 2008. It’s a very good time to be in a note,” he said.

The overall market environment was also favorable.

“We are in this sweet spot for energy shares. A bear market has already started in the overall market, but we’re not in a recession yet. That’s a good period to be long the sector,” he said.

One of the technical indicators he uses as evidence that a bear market is already underway is the divergence between the performance of the small-cap and large-cap segments of the U.S. market.

“The Russell 2000 has been down for more than a year and is not even close to recovery. It’s still down 12.85% from its Aug. 31, 2018 high. Meanwhile the S&P hasn’t dropped much, being only 1.5% below its July 26 all-time high.”

Insiders

Recent buying activity from insiders is a bullish signal for energy stocks, raising the odds of an automatic call, he said.

“We’ve seen very intense insiders’ buying of many of the energy companies, including Occidental Petroleum, in the past weeks,” he said.

Insiders are very “price-sensitive,” he said. As regulations require them to hold what they buy for at least six months, they tend to have a long-term outlook, carefully looking for the right entry and exit prices.

“The fact that there’s been such so much buying by insiders is a statement of their perceived value of the stock,” he said about the underlying.

Ahead of a recession

Energy shares tend to do well in the beginning and the middle of a bear market, he said.

“Then they collapse with everything else.”

This pattern was observed at the beginning of the 2007-08 bear market but also early on during the 2000-01 and 1972-03 bear cycles, he noted.

“As long as you’re not in a worldwide recession, which reduces demand for just about everything, energy is likely to outperform,” he said.

“It’s too early to be in a recession. The S&P is still high. Besides, everybody is talking about a recession, which is a clear sign that it’s not happening yet,” he said.

Dollar, Fed

Energy stocks will also benefit from a weaker dollar.

“When U.S. stocks begin to fall, investors move money into non-U.S. assets. The dollar will depreciate as a result of this. As long as we’re not in a recession yet, the decline of the dollar can extend for a certain period of time. It was certainly the case from the beginning of 2007 until July 2008.”

When stock prices begin to slide, the Federal Reserve is also likely to intervene. Any easing scenario will benefit commodities and therefore help oil stock prices move higher, he added.

“The Fed may be cutting rates if there’s a pullback, which will create inflationary pressures. That will compress real interest rates, which is what investors look at when they search for yield,” he said.

“We’ve seen inflation accelerating in the beginning of 2000 and in 1972. You always see inflation picking up in the early phase of a bear market.

“People can’t imagine the return of inflation right now because we haven’t had inflation in so long, but it’s inevitable.”

Commodity prices will thrive under an inflationary scenario.

“When you have negative returns from putting money in the bank, it makes it more attractive to own commodities. People are more interested in buying non-yielding assets when Treasuries or money market funds carry negative real interest rates.”

Short duration, low barrier

Another attractive aspect of the trade was its duration combined with the barrier level.

“The timeframe is right as we’re not in a recession,” he said.

“We may be in a recession in 15 months when the notes mature, but chances are they won’t mature.

“There’s a very high likelihood that you’ll be called away after six months; if not, after nine.”

If the notes are not called, the 40% downside protection should be sufficient.

“You’re getting in at a very depressed level. And the 40% barrier is very generous. The stock is unlikely to fall more than 40%.”

High chances of winning

Overall, the notes offer a high probability of earning an 11.5% annual return, although perhaps not in its entirety since the duration will be shorter than the stated maturity.

Kaplan said he liked the notes as they offered somewhat of a value play.

“Everyone is rushing to buy the shares of tech stocks that everybody else is buying ... the Amazon, the Netflix, the Apple,” he said.

“Energy shares are ignored even though they’re trading at a bargain.

“Technology stocks are overbought. People are staying away from oil and gas.

“The market is making sure that only a few people make money.”

The notes will be guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will settle Oct. 15.

The Cusip number is 48132FTP1.

© 2015 Prospect News.
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