UBS’ $1.9 million stepdown trigger autocall on crude oil to allow full payout, adviser says

By Emma Trincal

New York, Feb. 5 – UBS AG, London Branch’s $1.9 million of 0% step-down trigger autocallable notes due Feb. 16, 2022 linked to the relevant nearby ICE-traded Brent crude oil futures contract offer investors an investment timeframe and structure, which would allow them to fully benefit from the call premium as the “early” redemption of the notes is more likely to happen near maturity, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

His prediction reflected his outlook on the stock market and the economy.

The notes will be automatically called at par of $10 plus a call premium of 12% per year if the asset closes at or above its call threshold level on any quarterly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The call threshold level will be equal to the initial asset level for every observation date except for the final observation date, on Oct. 29. For the final observation date, the call threshold level will be 70% of the initial level.

If the notes are not subject to an automatic call, then the final level of the asset will be less than 70% of its initial level, and investors will be exposed to the decline of the asset from its initial level.

Memory, term

“The way it’s structured seems favorable to investors. The term is also right. One year will give the oil market enough time to be up,” said Kaplan.

The memory feature of the snowball payout, allowing investors to accumulate the quarterly call premium later, was one of the most attractive aspects of the structure, he noted.

“It’s better if you have a chance to wait without missing out on previous payments. The structure gives you that opportunity. If the call happens later, that’s good news: you get the higher return,” he said.

Such a feature would not offer any advantage if the notes were to be called early. But Kaplan does not anticipate such an outcome.

“You won’t get called in the first or second quarter. Your chances of being called will increase as we get to the third or fourth quarter,” he said.

This is because oil prices will drop first before going back up, he said.

“The chance for oil to stay low for the whole year is unlikely. We’ll see a rebound before maturity but probably not immediately,” he said.

The timing of the notes seemed to be aligned with Kaplan’s economic and market outlook for the year.

The portfolio manager expects the stock market to drop before the middle of the year followed by a recovery rally in the second half. Such market rebound will be supported by consumer spending as a larger number of people will become upbeat about the end of the Covid-19 pandemic, according to his scenario. These inflationary forces will also be conducive of a weakening of the dollar and a rise in the price of oil.

But things will get worse before they get better.

Looming correction in oil

“Crude oil has rebounded since last spring. On a long-term basis, the price is still relatively low. I see another price drop, but it won’t last indefinitely,” he said.

It’s this upcoming price decline which makes Kaplan doubt that the notes could be called on the first or second quarter.

“Prices of energy shares have deteriorated, and energy stocks are a good indicator. Producers are ahead of the commodity. They lead by several weeks.”

Oil prices will decline by mid-year, he said, based an analysis of recent price swings.

“Oil dropped last spring, went back up in June, dropped again in October and have been rising since. I don’t see any reason we won’t get another drop soon. Those past trends didn’t last more than four to five months,” he said.

Another indicator is the U.S. dollar, which tends to move inversely to crude oil.

“A strong dollar is negative for oil prices. And right now, the dollar is strengthening,” he said.

The U.S. dollar bottomed on Jan. 6 and has rallied since, he noted, adding that the index is at its highest level since November.

“At some point it’s going to be a negative for oil,” he said.

Bull peak

The next cycle to come will be a decline in stock prices followed by a swift recovery. Inflation will be impossible to ignore toward the end of the year, he predicted.

“The stock market is already on its way down. Insiders are selling at record levels,” he said.

It may not look like it. Reddit traders are frantically buying calls, new brokerage accounts are on the rise and indices are still making new highs, he noted. But these developments are merely the signs of a bubble ready to pop, according to Kaplan.

“Right now, most people are bearish on the dollar and bullish on the stock market. They don’t see the red flags: extreme speculation and dislocations within the market,” he said.

“If you take a closer look, more sectors have stopped rising. The breadth is deteriorating. Energy shares, travel, airlines, semiconductors, those are down. The only things that are not down are the big indices everybody is buying,” he said.

Meanwhile, the dollar is moving higher as more sophisticated investors are beginning to reallocate away from risky assets.

“By mid-year, even sooner, probably in May, we will see a big drop in stocks. The sell-off has already started even if you don’t see it. Again, it’s because people are fixated on the big indices right now and those are always the last to drop,” he said.

Drive my car

Kaplan offered an unconventional explanation for what will drive the sharp sell-off he expects to see in the spring.

“It’s going to be about the perception that Covid is no longer a threat, the idea that the worst of the pandemic is over,” he said.

“Instead of investors buying stocks and call options as they did during the lockdowns, they’ll go on a massive spending spree all over the world as the economies will reopen. It will have a direct negative impact on stocks with net flows out of the market going into the economy,” he said.

This would not be the first time the market and the economy will diverge, he noted.

“People have piled up so much money in the market. It’s likely they don’t have much left in the bank. I see a massive sell-off driven by the impulse to go on with the business of living. People will be booking flights, going to restaurants, driving their cars and travelling, spending money on all sorts of things. All this will spur inflation,” he said.

The risk of a slow vaccination process possibly overlapping into next year as well as the threat of new virus variants won’t stop the buying bonanza, according to Kaplan.

“It’s all about perception. People want to move on. We’re already seeing a lot of states opening up,” he said.

Short and mean

Kaplan said the upcoming slump in the stock market will be sharp and short-lived based on an analysis of bear cycles of the past.

“Bear markets tend to start with a very big drop. People panic. Then the market rebounds extremely fast, at least in the early stages,” he said.

He offered the examples of the dot.com burst. The first leg of the bear market only lasted a couple of months from March to May. By the end of May, the market rallied strongly even though each ensuing rally was too weak and too short to overcome the dominant downtrend. The same pattern happened with the 1929 crash, which erupted in early September and paused in the beginning of November as stocks rebounded at that time. A more familiar example was last year’s Covid-induced bear market, which lasted only a little over one month.

After the spring sell-off, Kaplan expects a recovery in the second half, he predicted.

“I expect oil prices to increase in the second half of the year. People will be driving more, they will be travelling more,” he said.

“In the second half of 2021, we’ll see a rapid transition toward inflation.

“As people begin to be aware of inflation, oil prices will rebound.”

This would bode well for investors in the notes.

“I’m pretty confident that a year from today, we’ll see much higher oil prices,” he said.

J.P. Morgan Securities LLC and UBS Investment Bank are the underwriters.

The notes settled on Feb. 3.

The Cusip number is 90276BPC1.

The fee is 1%.

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