'I'm going back to sleep'
This is the summary early this morning from Evercore ISI after the biggest-superlative-you-can-imagine move by the Fed. “So much for the impending consolidation.” Will we go from panic selling to FOMO? We’ve just had the largest-ever fiscal stimulus bill in history, bigger than even in the Great Depression after accounting for inflation, with more in the works, and a Fed that already has expanded its balance sheet beyond $5 trillion with no end in sight. This morning’s $2.3 trillion in lending and purchase facilities will support everything from small and midsized businesses to municipal and corporate debt markets, including riskier debt that extends to high yield exchanged-traded funds. Another first, OK. Even before this, money supply growth had surged 12% year-over-year and 27% on a 3-month annualized basis, both record highs dating to 1948. The Fed essentially is printing money, something it didn’t even do during the global financial crisis and subsequent renditions of quantitative easing, when it simply used excess bank reserves to buy bonds. Such actions historically have been associated with eventual rampant inflation. No one’s talking about that now, not with the economy crashing (weekly initial jobless claims jumped nearly 7 million again, prompting forecasts of 15% April unemployment) and core inflation running far below the Fed’s 2% target (0.7% year-over-year for March PPI).
Stocks seem to be making a bottom at a fairly rapid rate. While the S&P 500’s move off its record high into a bear market was the fastest on record, its 25% rally as of this writing off its March 23 low has been sharper than any of 13 previous waterfalls—even the one after Black Monday on October 19, 1987. There have been four 10-to-1 up days since March 1, the latest this past Monday. But the first three were followed by 10-to-1 down days. Ned Davis says a second 10:1 up day without an intervening 10:1 down day raises the likelihood the lows have been made, and at this writing, the market is having a 12:1 day. If it holds, this should be the all clear—that is to say, the lows are likely in. A retest could still happen and ultimately would depend on progress against the pandemic, a clear path to re-opening the economy and signs of eventually better economic and earnings data. Tuesday’s worst-ever reversal from up to down since October 2008 was a troubling sign volatility may remain elevated for the foreseeable future. Data going back 60 years shows that after waterfall declines, the S&P has tested its initial low about six weeks later on average. That would align with the arrival of weaker seasonality with May. Having broken through its 200-day moving average on Monday, the S&P at this writing has just pierced the next level of resistance, 2,792, which is followed by 2,940. While aided by short covering—the buying of stock positions that have been sold short—bets against the rally remain strong, with open interest on S&P “puts” at a record high.
This market isn’t trading on 2020 earnings because no one seems to know just how bad they’re going to get. Estimates are being cut at one of the fastest rates in the last 45 years, and we’re still in the early innings. Credit Suisse says in 13 recessions since 1935, it’s taken trailing 12-months earnings-per-share 2.5 years on average to regain their prior peak, with the fastest recovery occurring in just two quarters and the slowest in 17. Historically, it also has taken twice as long for earnings to recover relative to GDP. It’s almost certain this crisis will be steeper than most—many expect Q2 GDP to contract by at least 20% or more. But if the virus continues to exhibit signs of peaking, they also expect the economy to begin to quickly improve, suggesting the earnings recovery could be quicker, too. So, what is the market pricing in? As of early April, valuation spreads—the gap between multiples for the cheapest stocks and the market—were above 3 standard deviations and are particularly stretched for lowly valued stocks that tend to lead in recoveries off bear-market bottoms. In that vein, it’s noteworthy the worst-performing stocks from the last 12 months have outperformed the best performers by about 1,200 basis points this week in both the U.S. and Europe, consistent with what historically is found near market lows. Near-zero rates on risk-free assets make risk assets very attractive even for the defensives. As I see it, it’s a race between the virus subsiding and the economy getting back to near normal vs. a deep recession. And a race between the-biggest-superlative-you-can-imagine stimulus from U.S. monetary and fiscal policy vs. dollar relative strength. As a very thoughtful veteran in the business said this morning, “I’ll think of it tomorrow, at Tara. I can stand it then ... After all, tomorrow is another day.”
What are they really up to? Oil prices jumped on news that Saudi Arabia and Russia struck a tentative deal ending their price war, but by the end of trading Thursday, prices had fallen back over disappointment on the magnitude of planned production cuts. The agreement came a day after it was reported the Saudis had bought $1 billion of stock in four European oil companies. Oil prices need to stabilize if the world is to avoid a deep recession.
Small caps may be right where investors want them Q1 marked small caps’ fourth-largest quarterly decline since 1926, and March was their single worst month since October 2008. Moreover, small caps are trading at their lowest P/E multiple since 2011 and their lowest relative multiple to large caps in 18 years. Historically, small caps outperform coming out of market downturns and recession.
Contrarian positive Data at Tuesday’s close shows the most pessimism for stocks (21% bulls) and the most optimism for gold (68% bulls).
The data is only going to get worse Initial April Michigan consumer sentiment plunged to a 9-year low on its sharpest drop in its history, and mortgage purchase applications have plunged 11% and 12% the past two weeks.
Bureaucracy and small businesses don’t mix About half of small employers told the National Federation of Business they can survive for no more than two months. Their main risk is they don’t have the institutional relationships to access the paycheck protection program.
Not to mention, today’s biggest-yet Fed bazooka Over the past eight months, 285 stimulus measures have been announced, the most ever by a wide margin, and more are coming. Japan is preparing for almost $1 trillion and Trump and Congress are concurring on another $1 trillion. Including these two, there has been almost $10 trillion in fiscal stimulus announced around the world.
A social distancing experiment, but we are social animals! I live in a quiet suburb of Pittsburgh, where I can easily get my 5 miles per day walk in my own neighborhood. But at the base of the hill is a lake around which you can run for 5 miles. A very crowded place on a sunny day! The Mister won’t let us walk there anymore. My New York colleague lives by the beach, and on this beautiful day she’s sure that it will be crowded.
And when the dust settles? Covid-19 is likely to induce households to save more, just as occurred during the Great Financial Crisis. This excess of savings over investment should push the neutral rate lower, also as happened in the post-crisis era, meaning the Fed may not raise rates as high as the previous peak in 2018. The result: the whole yield curve should stay lower, flatter and closer to zero than in prior cycles.
Even if it’s a V, it may come too late for Trump An ironclad rule of politics is that recessions kill presidential re-elections, with Americans generally voting on the state of the economy around June, not November.