The bad, the ugly and the good
We must respect the words unprecedented and this is a big country. We just shut down the most of the economy, particularly services, for the first time ever. Unprecedented. This is a big country! The restart will be an unprecedented experience. Market bottoms historically precede the end of a recession by three months. Do you suppose this recession will be over by the end of May? Last week’s unprecedented 3 million surge in initial jobless claims could be worse this week. Credit Suisse thinks unemployment may jump from February’s 50-year low of 3.5% to at least 8% this spring. Renaissance Macro puts the number at 9.5%, citing a St. Louis Fed study that says 46% of the population is at high risk of layoffs, with most in low-paid occupations. Stocks are trading like it’s 2008, when big down and up days were hallmarks of that September-October period. After settling at a low in late November of that year, the S&P 500 rallied 24% the subsequent six weeks, only to resume its decline to March 2009’s cycle low—57% off its November 2007 high. The 35% current drawdown is at the high end of declines during recessions since the 1920s (the average decline being 25%). But numerous Wall Street strategists believe a sustainable bottom can’t be formed until U.S. infection rates peak and roll over. The U.S.—and Spain—currently are showing the worst trends. Key aggressive tactical indicators began flashing “buy” a week ago on a positive inflection from extreme negative readings, an indication the current rally’s unlikely to relieve all the selling pressure. Many Fundstrat clients believe the S&P could fall 50% peak-to-trough to 1,700. The virus will decide if that’s an outlandish number.
The bullish V-shaped recovery thesis draws skepticism from RBC Capital Markets, particularly since there’s been little discussion about the longer-term collateral damage from the public health crisis. There’s also been little talk about the costs of “Going Big.” It’s estimated the Phase 3 fiscal stimulus pieced together by the White House and Congress, along with monetary stimulus being unleashed by the Fed, represent nearly 20% of GDP, and they may not be done, with a Phase 4 stimulus expected to take the economy through the election. Unprecedented. This is after 238 global stimulus measures passed in the last eight months, during a mostly healthy worldwide economy. Stimulus has been “going big’’ since the thick of the financial crisis 12 years ago. I will explore this and its Modern Monetary Theory linkages in my next weekly. Despite all this support, financial conditions remain extremely tight. We suffered the fastest bear market in history (the transition from a bull to bear market typically takes about 10 months; it took 16 trading sessions this year), a spike in volatility to record highs, extreme widening in credit spreads and a strengthening dollar. This, and ongoing uncertainty about the ultimate magnitude and costs of the pandemic, continue to challenge liquidity. Gold, high-quality government bonds, stocks and, as TIS Group puts it, “anything else not tied down’’ is being sold for cash. Short-term Treasury rates have turned negative and money funds are experiencing their largest inflows in the 12-year history that Bernstein tracks, bigger even than at the height of the financial crisis. And the icing on the cake, with a powerful 3-day rally this week, the "shortest-ever bear market," as Strategas Research facetiously calls it.
It took China effectively three weeks to kill the epidemic, and the data so far show the West may be in an almost as effective shutdown. This means European and the U.S. economies could be heading for a gradual “smart” reopening (although Bill Gates in a CNN interview said that's "not smart" at all) by Easter (two weeks away … hmm), in line with a bad short-shock recession scenario. China has started reopening its economy, with an estimated policy response so far representing just 2% of GDP, far short of what we’re doing here in the U.S. and much of the West. So far, Evercore ISI sees clear signs of a fairly V-shaped recovery in Chinese consumption, even in highly discretionary categories such as fashion, luxury and sneakers. Here, the virus relief package is aimed at the bottom 60% of the income distribution, which represents a quarter of aggregate income and 35% of total consumption, and at small businesses, many of which carry little in the way of extra cash. Half of the participants in the Goldman Sachs 10,000 small business program said they’d only be able to continue to operate 0-3 months if the virus hit persists. Nine months from now, pundits suggest we may have a baby boom. I would agree with that, plus probably a surge in divorces. Now neither of those will describe my household where the Mr. does the cooking, suffers my personality (in smaller and smaller doses), and then we retreat to our corners.
- Technicians have taken notice that … The 50% retracement of a decline generally takes only half as long as the decline. This is true of the 10 30% declines since 1920. This implies the S&P could be back to 2,800 by mid-to-late April.
- If history is any guide With data going back to 1985, Bloomberg’s measure of U.S. economic policy uncertainty has risen to its highest level ever. Historically, big spikes in policy uncertainty have been consistent with bullish forward returns six and 12 months out.
- Prepare to go bigger than big Interviewed on NBC’s “Today Show” this week, Jerome Powell, when asked if he was prepared to spend an unprecedented amount, responded, “Essentially, we are.’’
- Retail isn’t bearish enough Investor bearishness held relatively steady at 51% in the latest American Association of Individual Investors survey. In the financial crisis, it rose to 77% in March 2009. Equity funds have seen large but not extreme outflows over the past four weeks as retail investors maintain positions in passively managed funds.
- Wither the uptick rule Billionaire hedge-fund investor Leon Cooperman told CNBC his biggest disappointment is the SEC's failure to deal with quantitative traders. He reminded viewers that, in response to wild markets during the Great Depression, the agency established the so-called uptick rule limiting short sellers to buying only at prices above current market levels. It abandoned the rule in 2007 and Cooperman’s shocked it hasn’t brought it back amid the record volatility of late that has left many investors, after looking at their 401(k)s and retirement savings, scared to death.
- Trouble in yet another corner The combination of falling asset values and rates has created the worst aggregate pension underfunding on record, according to Wolfe Research. Entering 2020, pension funding levels already were in significantly worse shape than in the past two market peaks, when they were overfunded by 22% and 4%, respectively. It’s estimated current plans are 30% underfunded.
If history is any guide Consumer discretionary stocks historically have outperformed the market by an average five percentage points in the year following a fiscal stimulus. After retests of market lows, small caps historically have tended to outperform in the subsequent three months. And in the year following 1987, 1998, and 2009 lows, the market rewarded beta more than any style.
Social distancing is no problem if you walk in my neighborhood Renaissance Macro suspects that, in a post-virus world, many people will want to move to the suburbs and away from crowds—a lasting legacy of our current shared experience and reversal of the recent back-to-the-city trend in many metro areas.
A silver lining In a post-virus world, TIS Group sees the beginning of a new “Buy American’’ era, with the costs to manufacture in the U.S. falling and the government/public seeing a vital need to supply from home much of what current comes from overseas.