The bazooka approach is out in full force with fiscal and monetary policies ramping up. The Fed was the first to act. Lucky for them, they just had to dust off the 2008 – 2009 credit recession playbook and apply their learnings. Instead of taking over a year to get things approved and voted upon, they accomplished their end of the stimulus measures in a matter of a few days. They are now buying as many assets in just one week compared to QE2 that took place over seven months. Their balance sheet is likely to double over the not-too-distant future.
The bulk of the Fed’s action helped calm the fixed income markets. Many mortgages were not able to be processed a week ago. Commercial paper spreads were astronomical. Municipal bonds could not even find a buyer unless they offered 5% yields, well above norms. This is slowly getting back to normal now. Rates have come down. The 10-year Treasury yield went from 1.27% to 0.81% in a few trading sessions. 30-year mortgages are back under 3.5%, with the 15 year under 3%. Deals are closing. Step one is working,
Looking back to the first implementation of quantitative easing, one can clearly see the positives it had on the stock market. Further, any time the Fed hinted at removing their QE measures, the stock market threw a fit and dropped. The Fed definitely kept rates too low for too long, but there’s no questioning the correlation of their balance sheet when compared to stock prices. See the below graphic. Correlation was extremely tight until Trump was elected and taxes were lowered. This helped give cover for the Fed to finally raise rates and reduce the balance sheet. That was certainly short-lived! If the Fed can grow its balance sheet to the $8T – $10T level, the corresponding S&P price level would be much higher than it is today. Don’t fight the Fed.
Step two is fiscal stimulus. The coronavirus bill, named the CARES Act, is almost at the finish line with a minimum cost of $2.2 trillion. The timeline of getting cash into consumer hands is not as fast as some need, but it will be coming. Loans/grants to small businesses are arriving as well. Loan forgiveness is tied to maintaining payroll, among other items. An eight week subsidy for labor, rent and utilities will go a long way in saving some of our favorite local small businesses. State and local funding is approved. Unemployment is boosted. Tax relief as well. In total, this represents 10% of annual GDP on the low end. Coupled with the Federal Reserve actions, we’re well over $5 trillion in stimulus into the system. Critically, this is happening in just a few weeks.
With half the country still not on lockdown, a lot of these checks are going to consumers who are hardly affected by the economic impact and closures. John Doe from Wyoming is still working 40 hours a week. His family of four will get $3,400 on top of their regular incomes. This additional cash is traditionally spent quickly. Other parts of the country will be using these funds to keep the lights on and food on the table. Although GDP is going to be a massive negative in Q2, it is unclear how quickly things can get back to normal. Consumers are still ~70% of GDP. The CARES Act will offset a lot of the downturn, but not all of it. Getting back to full employment, jam packed restaurants and crowded movie theatres will take a while. Other sectors will see a quicker rebound.
Recall, most “recessions” are built upon excesses and bubbles. The housing collapse of 2008, Y2K, Inflation in the 70’s…etc. This crash was self-induced with forced statewide closures. There were minimal excesses in the marketplace, outside of private equity valuations. P/E multiples were stretched, but hardly a bubble. The rebound may not mimic previous recessions. Leaders and laggards could be atypical after the initial pop.
After seeing economic records created in such a short time frame, the rebounds could be just as newsworthy, albeit in a positive way. We completed the fastest trip from new highs to a bear market in just sixteen days. It has now been followed by the shortest bear market in history. In just three days, we’ve advanced over 20% and technically entered a new bull market. New records everywhere.
What we have seen so far, is a massive beta rally off the bottom. The names beaten up the most have rebounded substantially. High beta areas like Consumer Cyclicals are showing amazing gains this week. Investors are getting a chance to reallocate to more solid long-term stories during this pop. Darden Restaurants, Marriott Hotels, Carnival Cruise Lines#, United Airlines and Boeing# have all nearly doubled already from their lows. This occurred while high quality stocks that held up well during the correction are hardly participating in this 20% move in the indices. Companies like Wal-Mart#, Activision#, Amazon#, Akamai Technologies and Costco# are hardly budging this week. These moves are short-term in nature and create the opportunity to shift capital to higher quality stocks over time. Again, low quality and those beaten down the hardest, have and will rally the most off the lows. High quality franchises could lag the near-term moves. It is a day trader’s market and fundamental manager’s worst nightmare.
The new trading range is a wide 500+ point area in the S&P 500 from the 2200 low to the resistance level around 2750. There are many schools of thought to get at this top of the range number. First, it is a 50% retrenchment of the entire downdraft. Many technicians will raise cash at those price levels based on historical precedence. It is also the area where the 200-day moving average exists. Recall, we were well above this area back in January, which was a cause for concern. Now that we overdid it on the downside, that level becomes new resistance. Further, investors become more skittish after a drop like this. Those who bought near the lows are sitting with 20%+ gains in a lot of names. Some will be quick to book profits.
Although the fiscal and monetary measures are massive, there is still near-term cause for concern today. On the one hand, the growth rate in new cases is slowing in the two largest Covid-19 breakout sites of Italy and New York. However, infection rates are picking up in other European countries and many States. The next New York could be another major city, or a dozen. New York is an international travel hub, so it makes sense they had the ramp in cases first, along with Seattle and California. With local flights ongoing and many states not closing up, the spread could just be delayed elsewhere. India just announced a three week lockdown. China is now closing their borders for incoming travelers. They do not want a reactivation in cases. A new explosion there would create another panicky market. We’re optimistic, but still need to see the data in new cases slow across the globe.
The upcoming economic data is sure to be dire. The market understands this. Even though we more than quadrupled the previous unemployment claims record with 3.28 million people filing in just one week, the market shrugged it off and advanced over 6% yesterday. Some quarter-end rebalancing also added to the gains as managers get clients’ asset allocation back in-line by adding back equity exposure. With the quarter coming to a close soon, the next several weeks will be loaded with earnings reports and updates. It is confession time. Nike# got away with providing minimal guidance and the stock advanced ~30% after earnings came out on Tuesday. Other companies without the stellar track record of the greatest shoe company around may not be treated with the same level of optimism.
As always, be prudent. If you nibbled on the way down, raising some cash from those whose fortunes have been forever changed wouldn’t be the worst scenario when we get to resistance levels. Even if you have to buy back slightly higher, prudence in these uncertain times is recommended. Ensure you have cash on hand for three to six months of bills. We may have ended the mass liquidation period and deleveraging phase but risk / reward after a 20% move is becoming more balanced today. Know your companies, review their balance sheets and make sure they are survivors in this new regime.
Today, Quentin Tarantino turns 56 and Mariah Carey is 49 years young.
James Vogt, 610-260-2214