The Relief Rally Continues Part III - How???

It's pretty amazing how far this rally has run.  The S&P has now retraced nearly to the 61.8%  level.  

The amount of stimulus has just been astronomical.  I haven't even discussed the latest round of $484B.  

I'm still defensive in positioning, but I think its worth assessing the aggregate price level of the S&P (SPY) with respect to where we have been.


Is the world really better today, than it was last October?



Here's my daily chart I posted some time ago, that outlined the V, U and L scenarios.

We are actually at the index price levels we saw late last year, before the market broke out on the relaxing of the trade war (remember that?) with china.

Is the world really better today, than it was last October?  How can the market really be pricing in a V bottom, when the economy has rocketing unemployment?  Really..  its not.  But here's how:

You've probably heard someone say, "the market is not the economy", and that's absolutely true.

In fact, individual stocks are not the market either.  And the market today, is not the market of last October - in terms of composition and long term prospects.  Let's use something familiar - your food expense, as an example.


Your Food expenses are now a part of the S&P Earnings

Here is a 1 year chart of MTY.TO (this is a franchise owner of about 50% of the food court malls/stalls in urban shopping areas, particularly in Canada).  And below is Walmart.  If you are like me, you haven't been to the food courts lately, and instead have spent a lot more on groceries, even though your total food expenses are down.

What does this mean for the S&P index?  I'm using MTY as a proxy for the vast swath of small businesses directly affected by the shelter in place order in plays, around North America.  Those businesses get crushed as their revenue essentially goes to near zero.  On the other hand, your food expenses now go to Walmart which is in the S&P.  (albeit less than 100% which would previously have been spent at food courts).  It should be clear to see now, that the economy itself (as represented by MTY, which is not in the index) is suffering greatly, but earnings for Walmart (and thus the S&P) in this case, is actually higher!

Back to the original discussion, of whether the world is worse off today, than it was back in October - it absolutely is.  But earnings in the index are not a direct reflection of that reality.  Nor has it ever been.  Don't take your queue on the market from the economy, and don't take your queue on the economy from the market.  Instead, this is the time where individual company analysis explains a lot more of what is happening in the stock market, than macro economics otherwise would.

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Risk Manager Jeff

What I'm Reading (2020-04-19)

Gilead's Remdesivir
I really feel like the market is grasping for hope here on the medical front.  Regardless of the market interpretation, this IS good news, and this article fleshes out some of the details that are missed in the headlines.
https://www.economist.com/science-and-technology/2020/04/17/is-remdesivir-the-drug-that-can-kill-the-coronavirus


Analyzing the Mortality Denominator (deaths / infected)
Don't read too much into the title of this link (below), as I believe it's rather misleading (and quite frankly - dangerous).  However, it does shed some light on the overall infection rate (the denominator) and mortality of Covid-19.  In a very brief overview, it suggests that based on the sample taken, and deaths observed in Santa Clara, the overall infection rate of the population is 2.49-4.16 percent with a mortality rate similar to the flu.  At 328M people in the US, that (using the provided rate) suggests a total infection of about 8M to 14M people in early April.  (At the time, the total confirmed infected was only about 250k-300k, implying a large population with only minor symptoms or entirely asymptomatic)  The other way to look at this, is to examine the ratio of infected to observed deaths.  However, the article makes note that does doesn't quite make sense for New York.  "One caveat is that a rough calculation applying the Santa Clara infection fatality rate to New York City's 11,000 COVID-19 deaths would imply that essentially all of city's residents have already been infected with the coronavirus. This seems implausible."

https://reason.com/2020/04/17/covid-19-lethality-not-much-different-than-flu-says-new-study/

What the study does not account for (which they admit) were some of the differences in populations, including age.  We know that New York largely accounts for many of the observed Covid-19 deaths.  A quick google search reveals some of the differences  between Santa Clara and New York.  Short answer: New York comes out worse on all counts.

• smoking rate Santa Clara  7.7%
• smoking rate New York 14.1%
• average age Santa Clara 33.9
• average age New York 38.2
• obesity Santa Clara 21%
• obesity in New York 27.6%

Given that Covid-19 is a respiratory disease, and is likely extremely aggravated by pre-existing conditions (potentially several hundred percentage points increases mortality), its very likely we can expect that the population of new York will experience a significantly higher mortality rate than santa clara.  (pre existing conditions also tends to correlate with age)

https://medium.com/microbial-instincts/meta-analyses-reveal-who-should-be-more-cautious-of-covid-19-9cbca0e9706d

As a result, I would content that mortality rates are not like the flu, unless you are young and healthy, and is significantly more fatal (perhaps exponentially) for older and populations with pre-existing conditions.

My investing takeaway from this, to focus more on stocks that not just benefit from a re-opening of the economy, but specifically derive their revenues from younger demographics.


Lessons on Economic Reopening - "suppress and lift"
We should have learned a lot more from what other parts of the world ahead of us in this pandemic experiences.  We didn't.  And again, we should learn more from how others are reopening.
https://www.vox.com/2020/4/17/21213787/coronavirus-asia-waves-hong-kong-singapore-taiwan\


Just an all around good interview from a really smart guy:  Bill Gates
https://www.cnbc.com/video/2020/04/09/watch-cnbcs-full-interview-with-microsoft-co-founder-bill-gates-on-past-pandemic-warnings.html


Chamath Palihapitiya
Chamath is a newcomer to me in my world.  He's someone definitely worth listening to.  You might not like what he has to say, but nevertheless, that doesn't make him wrong.  I'm particularly fond of his ability to silence the talking heads on CNBC.
https://www.socialcapital.com/annual-letters/2019

Unemployment Spikes - Is it different this time?

Does anyone even remember that the weekly jobless claims hit 6.6M last week?  The news was immedaitely overshawed by an additional $2.3 Trillion dollars of liquidty by the Fed.  Here's a rundown of late last weeks news and why it matters.

The Fed stated it would buy the bonds of “fallen angel” - companies that got downgraded from investment grade to junk.

Why does it matter?  In short, by buying junk bonds, the Fed is allowing companies to issue debt thereby adding fresh cash to their balance sheet in order to stave off losses.  One more step farther down the capital structure, and the Fed will buy buying stocks outright.

The Fed adds municiple bonds to assets it can purchase.

Why does it matter?  In one word - Taxes.  State and local governments cannot issue more currency.  This requires them to somewhat run fiscally balanced budgets.  To make up for shortfalls, they can either raises taxes on its citizens (further impairing the economy), or issue debt.  Just like the junk bond corporates, purchases by the Fed are giving states and local government an easy out.  Issue more debt.

Both of these are positives for the stock market at least in the short term.  At some point, the mountain of debt that is building up in the Fed's balance sheet will have to be reckoned with.  When, however, is anyone's guess.

On a relatively "minor" note, a mere $250B of additional funding for small businesses are being held up once again.   Small-Business Aid Stalls in Senate as Democrats Demand More Funds.  No doubt this is the current political football of the day.

The market itself is still sitting right in the technical resistance zone, where I advocate being more defensive.  If the market indeed is going to rally farther (and who knows what the multi trillions of dollars of liquidity can do), it's going to at least have to base for a period.  (a correction of time, not price)

To add to this, I want to go back to the forgotten 6.6M jobless claims.   While jobs are often viewed as a laggin market indicator, I can't stress enough how important jobs actually are for the stock market.  Below is a chart of the unemployment rate overlayed with the market, clearly showing the importance of jobs to the stock market.  While we have known for weeks now, that this number was going to spike hard, its worth comparing to the 2001 and 2008 recessions.

What is indeed different this time (vs 01 and 08), is that the Fed is not only acting quickly, it appears to actually be ahead of the curve - almost as if its actively on the hunt for any liquidity problems in any part of the financial system.  Will that make things different this time?  Actually yes, but its the degree to which it does, that cant be foreseen.  With respect to trading and investing, I have to assume we are in a bear market as delinated by the fresh new highs in unemployment - with no end in sight as of yet.

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RiskManager Jeff

Trading & Investing in the Relief Rally - Part II

In a previous article, i outlined what I believed was the most likely path and price target for the current relief rally.  I wrote:

"I would expect 2 different paths into this range, ultimately targeting 275.  Either we charge right into that area (as it seems like we have for the past 3 days), or my more preferred case (as depicted with the black arrows), we pause below (where we are today) before breaking out into the box above."   

So far, this has played out shockingly accurate missing 275 by mere pennies.  However, in fairness, this all happened a lot faster than I expected with a lot more gaps.

Now what?

I'm still believe that the Lower for Longer (L scenario) outweighs the U scenario 2:1.  In truth, it doesn't really matter, as both scenarios suggest some weakness in the near term which means getting more defensive and raising capital in the resistance zone.  From a valuation perspective, the S&P at about 2750 implies about a 16 forward PE (before major estimate cuts) and is not cheap.

Over the next few weeks I'm expecting a lot of choppy trading designed to frustrate both longs are shorts - probably more gaps and sharp end of day moves.  Personally, you won't find be buying on sharp up days, nor selling on sharp down days.  I continue to believe the best way to navigate this market is to continue to high grade your portfolio, and hedge (sell something or short an index) as needed.  The primary reason for doing this, is that it will ultimately lead you being generally on the correct path, regardless of a L or U scenario.

While I currently favour the L scenario, I have to accept that the government does not.  I suppose its not that much different of the government response to Covid-19.  Basically, the government continues to do more, until the curve is bent - or in this case, until the recession is halted.  And this is a playbook they are familiar with, from the 08/09 financial crisis.

1. Mnuchin Seeks Another $250 Billion For Small Business Stimulus Loan Program, Senate To Vote On Thursday
2. The Fed will start buying debt backed by emergency small-business loans — giving banks more leeway to offer critical aid

In terms of trading/investing, its more of the same.  Reduce exposure (or beta via hedges) in the resistance zone, and add to quality names lower.  Jettison anything directly impacted by Covid-19.  While it may be enticing to trade in retail, travel and leisure - these are purely trades at best.  As long as there is a chance their equity can be wiped out, it's something I'm not personally interested in.

Some things I consider for this next phase in this relief rally (or conclusion thereof) include:

1. Earnings:  Yes, earnings season is upon us, and I'm not expecting any good news.  At best, guidance is pulled.  "beat and raises" will be non-existant.  At worse - a lot of estimate cuts.
2. Economic news flow:  We are going to get more unemployment figures, and declining economic indicies.
3. Covid-19 news:  We'll be seeing some areas like NY begin to bend the curve, but deaths will still be rising.  Additionally, we can expect other cities begin their climb on the curve.  Fortunately, these areas should have the benefit of additional supplies that can be diverted to them.

None of these, I expect to be bullish.

With that said, its worth stating that my own strategy emphasizes capital preservation.  If I can 'dodge' another major decline, and maintain market exposure when the market eventually resumes its upward trend, I would consider that a success.

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What I'm Reading (2020-03-30)

I wrote last night that two essential developments are needed if we want to see a U bottom.

• Antivirals/therapeutics and a vaccine
• Antibody testing, in order to get people back to work safely.

There actually has been some significant developments.  Most notably Abbot Lab's 5 (ABT) min test, and J&J's (JNJ) large scale vaccine that could be available early next year.  Additionally, Henry Schein (HSIC) is releasing Covid-19 antibody tests.

• The US can bring people back to work safely if it follows these steps

• J&J and Abbott announce potential vaccine and rapid test

• How Covid-19 immunity testing can help people get back to work

I make particular note of these developments because while I believe the most probably scenario remains the L recession, part of being a successful investor is to remain flexible in thinking.  And these developments are unequivocal market positives.

L is for Lower for Longer

There have been three broad scenarios that is being debated by the market.  The V bottom (which i don't believe is even remotely realistic), characterized by a immediate recover.  A U bottom (recession & recovery), which is a longer and more persistent decline which ultimately recovers, and an L recession (global recession) which depicts a bear market, potentially taking months to complete and years to recover.

We are currently in the relief rally phase which I think will take some time to play out.  This phase should end with a decline in volatility.

U Bottom vs L Recession

It's worth analyzing the factors that support the U vs L scenarios.  Personally, I believe the odds of the L scenario (global recession) outweighs the U scenario 2:1 (or about 67% favouring a L scenario).  While I can make the case for both, I find the L scenario more plausible.

U Bottom

QE/2T+ stimulus:  It would seem that authorities have learned a lot from the credit crisis and have leapfrogged ahead of the curve with massive stimulus.  Don't fight the Fed.
Antivirals and Vaccines:  With global efforts of really smart people working to combat the pandemic, it is possible that antivirals/antibody therapies capable of treating Covid-19 are discovered.
Antibody testing:  This isn't the usual test that is being talked about, but we have to start to get a handle on people that have already had Covid-19 and have developed antibodies.  This could allow more people get back to work, but I have yet to hear any significant progress in deploying this at scale.


L Recession

Rolling infection waves: While individual regions are able to somewhat predict when they will have peak Covid-19 cases, they have yet to address how to contain Covid-19 afterwards (safely sending people back to work).  As one area becomes contained, breakouts occur elsewhere which ultimately result in a continuous flow of outbreaks.  China itself, admits to having challenges now dealing with imported cases.  Worse yet, there STILL seems to be regions that are not taking the pandemic seriously.  I believe this is human nature - that the majority of the population will not respond until it directly affects them.  If this is true, then every major city (and country) needs to have its "New York" or "Italy" moment.

Demand destruction due to fear:  Assuming we can deal with the above, getting people back out to spend will prove to be a challenge unless there are effective treatments and a vaccine.   Even with QE/2T+, there's no amount of money sufficient to get the population to wade back into murky waters with a hungry Covid crocodile still on the hunt.

Vaccine 12-18 months out:  A vaccine is sorely needed.  However, by the industries best/optimistic estimates, it is still at least a year out.  This includes testing for efficacy, safety, manufacturing and distribution.

Re-Pricing of Risk:  I think this one is particularly important for the markets, but rarely discussed.  The outcome of the 08 recession was a repricing of credit and safeguards placed on the banking system.  The result of the Covid-19 recession, will cause a repricing of supply chains, placing safeguards on the manufacturing of critical supplies.  This includes very basic commodity products (aspirin, masks, components parts).  This inherently adds cost into the system and furthers the breakdown in globalization.

Regarding these two scenarios, it's important not to get too rigid into one particular belief.  Remain open to new information as its presented.  With respect to investing, use the current relief rally to exit any stocks directly in the Covid-19 blast zone.

I'm still thinking through a longer term investment thesis, but there are four broad themes I'm confident in today.

High Yield: (Be careful with dividends - assume cuts and changing consumer behaviours)
Growth Mega-cap: (Scale matters, and Mega cap stocks will inevitably take share)
Leap of Faith stocks: (looking through the Covid-19 valley, life resumes.  Humans are social creatures of habit.  We eat, shop and seek entertainment.  Some stocks offer tremendous value if you have faith that life goes on)
Gold: (massive stimulus isn't unique to the US)

Risk Manager Jeff

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Trading & Investing in the Relief Rally

In my last article, I outlined 3 phases and its clear that we are in the phase 2 relief rally.  In this article, I want to spend a little time on the chart technicals.  These relief rallies often retrace about 50% of the decline which is at $280 for the SPY (S&P 500 ETF).  Additionally, we can easily draw a few overhead resistance lines, essentially all of which are within the black box I've drawn.  

I would expect 2 different paths into this range, ultimately targeting 275.  Either we charge right into that area (as it seems like we have for the past 3 days), or my more preferred case (as depicted with the black arrows), we pause below (where we are today) before breaking out into the box above.

At 275, the market would have sufficiently 

• worked off oversold conditions
• made typical bear market re-tracement
• run up against horizontal resistances lines 
• run up against the downtrend starting back on late February at the market top
• run up against major falling moving averages

In the last article, I also characterized this relief rally to be lead by momentum traders buying, ultimately countered by fundamental sellers.  I'm just going to use Carnival Cruise Lines (CCL) as an example, but there are many to choose from that offer similar characteristics.  These are the companies most impacted by Covid-19 (cruises, airlines) and have rallied the hardest from the bottom.  CCL reversed from $8 to $18 in the past 3 days - a prime example of aggressive momentum traders.  As we approach the top of the relief rally, we should see 

• sellers stop the rally (lack of buyers) in these most beaten down sectors
• a rotation once again into more defensive names (utilities, healthcare, large cap secular growth)
• a rotation into value names - i.e. financials

I believe this is where we are now, observing that utilities and healthcare outperformed today.  The market may also be front running the necessary bond/equity rebalancing at the end of March for Q1.

Personally, I would use this opportunity to sell any remaining positions that are directly affected by Covid-19 to raise cash.  If you're an investor, you shouldn't have any.  And if you're a trader, its time to take profits.

On a pullback, I would be looking to add to still damaged stocks, but names that offer value when looking out 5 years from now.  This includes many of the big tech names, and certain quality blue chip companies.  I would also look at high yielding companies that perhaps have been caught up in the broad market decline that have yet to recover.  These could augment the cashflow portion of a portfolio for many years to come.

In my next article, I will outline my longer term thesis in a "Post Corona World" and specific stocks that should benefit from secular trends.

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Risk Manager Jeff