The record books are being rewritten during this malaise. We’ve experienced eight straight days of at least 4% moves in the S&P that finally ended yesterday. The previous record was only six, dating all the way back to 1929. The very short end of US T-Bills turned negative out to six months at -0.02%. The VIX (fear index) broke above previous record highs set in 2008. The Russell 2000, which is primarily made up of small cap stocks, lost 42% in just 20 days, a new record and vastly worse than their large cap brethren this year. Thursday saw a massive reversal as the index was 634bps ahead of the S&P in just one day. Small caps have much more sensitivity to credit markets and daily business cash flows.
The S&P was down 16% in just seven days, while the 10-year Treasury doubled in yield. That is the exact opposite of a normally functioning marketplace. In these craziest of times, even Representative Ilhan Omar complimented Trump’s plan to help Americans with their mortgages and cash flow issues. On a positive note, oil had its best day ever on Thursday with a 24% gain in one session; which doesn’t help much from the highs, but encouraging nonetheless as we search for a bottom.
In addition to Jim Meyer’s comments on the mass liquidation of ETF’s and overly levered hedge funds, you have the fundamental reasons behind this as the need for corporations, banks and consumers being forced into raising cash. They can only sell what they own. Banks have to sell Treasuries when companies drain their credit lines and access that cash. Consumers who have no income over the coming weeks have to put food on the table. So they sell. Small businesses who are shuttered still have to pay their rent/utilities/insurance/payroll while getting nothing in revenues. There is minimal long-term investment analysis being done here. It is “sell at any price”. When that ends is anyone’s guess. Most of the quarantines are set for 2-4 weeks. Realistically, it will be 4-8 weeks and even possibly longer for cities with extreme cases. Some have raised enough cash, others may not be so lucky.
The unknown in all of this is time and money. Most small businesses can handle a gradual slowdown preceding a recession. A 10% – 20% drop in revenues is manageable over a year or two. Going straight to zero overnight is unheard of and will hit thousands, if not millions of companies. Many entities operate with daily cash flow in and out of their balance sheet. Cutting off one end and keeping the other open is a recipe for disaster. Jobless claims will skyrocket and break the 2008 highs of 700,000. It would not be surprising to see this double the previous record, and soon.
Fortunately, this will run its course over time. The market knows what we know, and then some. We are starting to see some small signs of a bottom forming as well. Great long-term values are being created. World-class operators are seeing wild moves down, only to close the trading day at their highs. Yesterday, in just a few hours #McDonald’s went from $128 to $150, #NXPI from $63 to $73, Marriott from $52 to $66 and #Keycorp bounced 24%! Stocks are set for another bounce this morning, so far. However, it is not time to chase rallies higher. Make sure you have enough cash to pay bills for the next 3-6 months. Slowly nibble on big down days. Retests are probable as the virus news is likely to get worse over the coming days with a ramp up in new cases. California is shutting down with authority. Governor Wolf in Pennsylvania announced similar measures. Others will follow.
Some investors follow the rules of “smart” and “dumb” money. The term refers to retail investors trading during the first hour while institutions trade the last hour of the day. You want to follow the institutions who have a lot more information than the average investor. We keep seeing money creeping into the market towards the closing stages. This is constructive and shows a desire for institutions to increasingly put some risk back on. Closing near the highs for the trading day is a solid sign. However, in order to confirm a bottom, we need a few solid positive days and a retest that holds above the 2280 levels in the S&P that were set this week. There will be rolling bottoms. Some names/sectors may have hit them already, others have more risk. Pockets of staples, healthcare and technology sectors are working on this bottom now.
The virus data is on schedule to start showing a near doubling of new cases every day for a while as more testing is available and the spread thickens. Quarantines will work, but not as well as if everyone followed the rules. Spring breakers are not helping. Jam packing food stores and bars doesn’t make much sense. New York City wants to declare Martial Law. One of the reasons why Wuhan had zero new cases of the virus on Wednesday is because of full governmental control over the city. They forcibly locked everything down. It’s a scary thought in a free world.
The Chinese stock market bounced back to their previous highs a few days after the number of new cases peaked. It has since turned down once the virus expanded into their largest customer, namely the US. However, most of the large cap leaders in their markets are handily outpacing the current market returns here at home. They took their pain and were rewarded, albeit by being down less. We are at least four weeks behind them at the moment.
Uncertainty is running wild. Any signs of a slowdown in the outbreak would be a solid data point for which we can analyze the economic effects. Right now we don’t know if this shutdown will be through April or the entire summer. The market hates unknowns as much, if not more than, bad data. For now, we can only look at previous instances of rapid declines similar to this and the only thing close is World War II. Even then, we had a gradual slowdown in sectors before the ramp up in production of weapons. This could be WWII condensed into just a few months from a small business perspective.
On the positive news front, there are many trials coming out with improving results to battle Covid-19. Since coronaviruses have been around for a while, we know a lot about them. Each one is unique but the game plan is a good starting point. There are 41 vaccines under development already. Some first line oral and even generic antivirals are showing suppression rates that cut the time from 11 days to 4 days of serious health concerns. Our Veterans may recall the malaria drug Chloroquine, which is showing some positive effects and is in good supply at very low costs. These studies are not in a typical setting so many will wind up being failures. With billions of dollars being thrown at this on a global basis along with some of the brightest minds in the world, we are hopeful of something concrete happens before the next flu season ramps up.
After the peak negativity comes in, we still have major economic consequences to clean up. The Federal Reserve has opened up their playbook from 2008 – 2009 and has jumped in accordingly. When commercial paper rates are 100bps above the prior day (and yielding 105bps), there are issues. So far, we’ve seen $1.5T in Repo Operations liquidity provided, $1.1T in commercial paper, a likely $1.3T in fiscal stimulus (basically money dropped from helicopters), $750B and $600B QE measures from the Fed, $600B in loan guarantees from France + UK, $500B in loans from Germany, a proposed $300B in Japanese stimulus among many more measures. Yes, those numbers are real and unfortunately, necessary. The globe will print over $10T in short order to combat this quick decline in business activity.
The end result from a long-term perspective is unknown. One would think that the 2008 money printing measures would have led to rapid inflation. We got the opposite. A lot of money will be spent keeping bad businesses afloat, albeit a lot of good ones will be spared bankruptcy from something that is out of their control.
Stocks have to readjust to a new world that is forever changed. Winners and losers are apparent. Businesses are realizing they can get more and more work done from home. Office REIT’s can be in trouble. If you have two floors downtown, you can save a lot of money allowing employees to work online and cut massive fixed costs by moving to just one floor. Spending will certainly increase faster than expected for networks, servers, laptops (my Best Buy was sold out), monitors, cameras, fiber optics and food delivery. How many people tried online ordering for the first time at #Wal-Mart or #Amazon? If the execution side of this works well, they have clients for life, and driving to the nearest market becomes even rarer. They are both hiring tens of thousands of new workers already from this disruption.
The travel industry is on the other side of the coin. Some really expensive conferences were done via virtual meetings this month and next, saving thousands of dollars. If business can be conducted without getting on a plane and wasting an entire day traveling, it will continue. Working from home eliminates a lot of driving. More retailers will go bankrupt faster than before Covid-19 as the online crowd expands. Movies being released online during this downturn means theaters could be slow to recover. Some of these areas have been hit so hard that the stocks offer great values but the overall outlook has to be lower than before.
The overall stock market could resemble that of 1987, which has an unusually tight correlation so far as you can see below (2020 S&P is red, 1987 is black):
As winners and losers are realized, a back and forth sideways market makes some sense until we have more certainty on government stimulus plans and how long we are shut down. The initial pop from the lows can be sizeable, but a retest is typical. 1987 did not have the massive global printing presses working overtime so, again, we are working on a brand-new script. History doesn’t repeat itself but it often rhymes.
Today, Baron Trump turns 14, director Spike Lee turns 63 and yours truly turns 45. Our gift to you is the first day of Spring, enjoy the nice weather!
James Vogt, 610-260-2214