What a week! Last Sunday night, it looked like Warren Buffett's somber tone last weekend would spook markets into selling off and reflecting the horrendous underlying economic reality. But markets finished Monday in the green and only had one red day for the week.
However, trading volume was really low all week. Basically 1/2 of normal. And there was weakness into the close much of the week. Weakness into the close and markets drifting higher on anemic volume doesn't point to "the new bull market" that some CNBC talking heads say is here.
It was really the week of Jobs Reports. We got ADP on Wednesday, Initial Claims on Thursday, and Monthly Payrolls on Friday. All of the reports were horrible - but modestly better than expectations. And beating expectations is what Wall Street cares about. However, in a "normal" market stock prices reflect a balanced future. So a realistic view of the future. It seems that stock prices are reflecting a nearly perfect future today - so bad news should be pushing shares lower. But the Federal Reserve is viewed as a backstop to any non-perfect scenario - and thus weakness is to be celebrated because the Fed will come in with their money helicopter. And good news is also celebrated because it's good news. It's perverse, really.
We've been investing in stocks since 2005 and since 2009 as "professionals". There has never been a market so out of touch with reality - except maybe 2009-2010. But back then, stock prices reflected the worst case and it took a Herculean amount of good news to send shares up. We're exactly opposite of that today - it takes the worst news possible to send shares down, and even then they can't stay down. Disney's earnings report this week is an example of that.
Since it was Jobs Week, let's talk about that a bit. The data is the worst ever in absolute number terms and speed of the decline. The Bank of England had to go back to 1706 to find a comparable period.
The consumer is hurting. Employment participation is plummeting.
Credit is being tightened. Credit utilization is crashing. People are hoarding their cash.
Those low interest rates that we see on U.S. Treasuries? They're not flowing through to consumers.
The silver lining from the Employment Report was that Average Hourly Earnings were UP!
However, the reason Average Hourly Earnings were up is that the lower income jobs were the ones that got cut! Real earnings weren't up - this means that the normal person is worse off. More money is flowing to the top than before - and that could lead to social unrest. Income inequality is a real issue in this election cycle - it has been for a while, but seems to be growing in importance - and top jobs being saved while bottom jobs are cut just feeds that narrative even more. Watch closely.
To expand a bit on interest rates and the lower Treasury rates not flowing through to the economy, let's look at High Yield credit spreads. They've blown out and are pricing in the obvious recession+. Spreads usually lead the market - which is why many investors think the bond markets are smarter than equity markets.
Let's talk a bit about the stock market's valuation. It's expensive by almost any measure. Historically expensive.
It doesn't help that guidance is being slashed across the board. Even companies that see a "V-shaped" recovery pulled guidance - Apple, specifically. Tim Cook, Apple's CEO, told President Trump that he think the economy will rebound quickly. A few days later, Apple pulled 2020 guidance.
PEG ratio is never one we've used or put much thought into. But it's also showing beyond extreme stock valuations. (PEG is P/E divided by long-term EPS growth. Higher growth justifies a higher P/E because it means a brighter future. Growth rates and P/E tend to move together and stabilize the PEG ratio. These two measures have split - driving PEG higher.)
If you put the stock market up against any data point that has an historical relationship, stock markets are beyond bubble levels.
Here is the NASDAQ vs. Payrolls. It's illustrative of this point.
Moving on.
Fed Fund Futures began pricing in NEGATIVE policy rates this week - beginning in November of this year and beyond.
Negative policy rates would mean that the Fed would pay banks to take money. Or loan money and not require all of it to be paid back. Think of how insane that is! As negative rates flow through the economy, savers are punished - because they no longer get paid interest. They actually get charged to hold money in the bank! It's a smarter move to BORROW money than to SAVE money when rates are negative. Get paid to borrow or pay to save. That's truly perverse.
While it's clearly stimulative to the economy to punish saving and reward spending/investing, it has massive implications to asset prices. Demand for credit goes up, asset prices go up, and therefore inflation spikes. Staying with negative rates is dangerous for very long.
Which is likely why Fed Chair J. Powell is very much against negative rates. It's unsurprising that after seeing Fed Fund Futures go negative, he scheduled a speech for next week. Fed Fund Futures immediately went back above zero. He knew what he was doing.
Without going negative on rates, Powell's only choice is to continue QE and pump as much credit as possible into the economy. But if consumers can't access that credit and don't want to - because they don't have jobs, income, or assets - then all of the easy money flows to the "haves" at the expense of the "have nots." Further giving rise to that social unrest we talked about with which jobs are being cut.
Moving on, President Trump is talking about the next phase of his series of trade deals with China. He claims to be on Phase 4, but Phase 1 isn't being implemented yet - so it's hard to tell how he's numbering his phases.
In the same breath, Trump wants "reparations" for starting the pandemic to be paid by China. It's hard to see why China would give in to a trade deal while being asked for reparations. And remember, the first phase of the trade deal was all the stock markets cared about in 2019. The fact that Phase 1 isn't being realized should be reflected at some point in stock prices - it remains another example of the stock market not pricing in economic reality.
Finally, let's talk about how well various world leaders are being rated by their people since the pandemic was declared. Trump's approval rating is up slightly since the declaration. But many European leaders have seen their ratings increase much more dramatically. Brazil's leader, Bolsonaro, has seen his rating drop 10 percentage points vs. Australia's Morrison jumping nearly 30 points.
For those of you who have followed the "Swedish model" for attacking the pandemic, here's how they're comparing in terms of deaths to their closest neighbors. They knew they'd have more deaths, faster. That was the plan. But the right-wing media in the US that wishes we'd used their model doesn't seem to talk about the costs of the plan.
Phew. A lot of stuff to think about, but that's the world we're in right now.
Study is a key part of investing - and the need to study ebbs and flows. When there's a disconnect between your view of markets and what happens in markets, looking at data can show whether you're crazy or not. We don't think we're crazy for thinking markets need to go meaningfully lower. And we're studying the data to figure out if and where we could be wrong.
Let's look at the week ahead:
Starting with earnings reports, we have a good mix this week.
We're currently 19% net short equities and 35% gross equities. When we consider our bond and gold positions, we're 4% net long and 60% gross exposed.
It would be great to get net short exposure on equities down to 10% after the next drawdown. Pushing shorts further on any rallies seems rational. Though investing in a market that won't fall is like walking on thin ice - it's all fine until one step causes a crack and next thing you know you're drowning in the frozen water.
Finding more long positions has been difficult. On the list right now are tech companies with low leverage and high dividend yields, a small group of U.S. utilities that can grow earnings without growing customer bills, gold/silver miners, and adding to existing positions.
The list of short ideas includes retail, restaurants, hotels, home builders, banks, real estate, manufacturers, oil producers, and more.
If U.S. Treasury yields rise, we'll add to EDV and TLT this week. If they spike, ZROZ will join the fold.
Gold is a position we max out at 10%, so it would take some real weakness to add more. Similarly, it would take a big gold rally to make us sell.
That's it for this note. We'll be out tomorrow morning with our Daily Note. As always, drop a comment below with your best ideas and anything else you want to share.
Good luck out there.
However, trading volume was really low all week. Basically 1/2 of normal. And there was weakness into the close much of the week. Weakness into the close and markets drifting higher on anemic volume doesn't point to "the new bull market" that some CNBC talking heads say is here.
It was really the week of Jobs Reports. We got ADP on Wednesday, Initial Claims on Thursday, and Monthly Payrolls on Friday. All of the reports were horrible - but modestly better than expectations. And beating expectations is what Wall Street cares about. However, in a "normal" market stock prices reflect a balanced future. So a realistic view of the future. It seems that stock prices are reflecting a nearly perfect future today - so bad news should be pushing shares lower. But the Federal Reserve is viewed as a backstop to any non-perfect scenario - and thus weakness is to be celebrated because the Fed will come in with their money helicopter. And good news is also celebrated because it's good news. It's perverse, really.
We've been investing in stocks since 2005 and since 2009 as "professionals". There has never been a market so out of touch with reality - except maybe 2009-2010. But back then, stock prices reflected the worst case and it took a Herculean amount of good news to send shares up. We're exactly opposite of that today - it takes the worst news possible to send shares down, and even then they can't stay down. Disney's earnings report this week is an example of that.
Since it was Jobs Week, let's talk about that a bit. The data is the worst ever in absolute number terms and speed of the decline. The Bank of England had to go back to 1706 to find a comparable period.
The consumer is hurting. Employment participation is plummeting.
Credit is being tightened. Credit utilization is crashing. People are hoarding their cash.
Those low interest rates that we see on U.S. Treasuries? They're not flowing through to consumers.
The silver lining from the Employment Report was that Average Hourly Earnings were UP!
However, the reason Average Hourly Earnings were up is that the lower income jobs were the ones that got cut! Real earnings weren't up - this means that the normal person is worse off. More money is flowing to the top than before - and that could lead to social unrest. Income inequality is a real issue in this election cycle - it has been for a while, but seems to be growing in importance - and top jobs being saved while bottom jobs are cut just feeds that narrative even more. Watch closely.
To expand a bit on interest rates and the lower Treasury rates not flowing through to the economy, let's look at High Yield credit spreads. They've blown out and are pricing in the obvious recession+. Spreads usually lead the market - which is why many investors think the bond markets are smarter than equity markets.
Let's talk a bit about the stock market's valuation. It's expensive by almost any measure. Historically expensive.
It doesn't help that guidance is being slashed across the board. Even companies that see a "V-shaped" recovery pulled guidance - Apple, specifically. Tim Cook, Apple's CEO, told President Trump that he think the economy will rebound quickly. A few days later, Apple pulled 2020 guidance.
PEG ratio is never one we've used or put much thought into. But it's also showing beyond extreme stock valuations. (PEG is P/E divided by long-term EPS growth. Higher growth justifies a higher P/E because it means a brighter future. Growth rates and P/E tend to move together and stabilize the PEG ratio. These two measures have split - driving PEG higher.)
If you put the stock market up against any data point that has an historical relationship, stock markets are beyond bubble levels.
Here is the NASDAQ vs. Payrolls. It's illustrative of this point.
Moving on.
Fed Fund Futures began pricing in NEGATIVE policy rates this week - beginning in November of this year and beyond.
Negative policy rates would mean that the Fed would pay banks to take money. Or loan money and not require all of it to be paid back. Think of how insane that is! As negative rates flow through the economy, savers are punished - because they no longer get paid interest. They actually get charged to hold money in the bank! It's a smarter move to BORROW money than to SAVE money when rates are negative. Get paid to borrow or pay to save. That's truly perverse.
While it's clearly stimulative to the economy to punish saving and reward spending/investing, it has massive implications to asset prices. Demand for credit goes up, asset prices go up, and therefore inflation spikes. Staying with negative rates is dangerous for very long.
Which is likely why Fed Chair J. Powell is very much against negative rates. It's unsurprising that after seeing Fed Fund Futures go negative, he scheduled a speech for next week. Fed Fund Futures immediately went back above zero. He knew what he was doing.
Without going negative on rates, Powell's only choice is to continue QE and pump as much credit as possible into the economy. But if consumers can't access that credit and don't want to - because they don't have jobs, income, or assets - then all of the easy money flows to the "haves" at the expense of the "have nots." Further giving rise to that social unrest we talked about with which jobs are being cut.
Moving on, President Trump is talking about the next phase of his series of trade deals with China. He claims to be on Phase 4, but Phase 1 isn't being implemented yet - so it's hard to tell how he's numbering his phases.
In the same breath, Trump wants "reparations" for starting the pandemic to be paid by China. It's hard to see why China would give in to a trade deal while being asked for reparations. And remember, the first phase of the trade deal was all the stock markets cared about in 2019. The fact that Phase 1 isn't being realized should be reflected at some point in stock prices - it remains another example of the stock market not pricing in economic reality.
Finally, let's talk about how well various world leaders are being rated by their people since the pandemic was declared. Trump's approval rating is up slightly since the declaration. But many European leaders have seen their ratings increase much more dramatically. Brazil's leader, Bolsonaro, has seen his rating drop 10 percentage points vs. Australia's Morrison jumping nearly 30 points.
For those of you who have followed the "Swedish model" for attacking the pandemic, here's how they're comparing in terms of deaths to their closest neighbors. They knew they'd have more deaths, faster. That was the plan. But the right-wing media in the US that wishes we'd used their model doesn't seem to talk about the costs of the plan.
Phew. A lot of stuff to think about, but that's the world we're in right now.
Study is a key part of investing - and the need to study ebbs and flows. When there's a disconnect between your view of markets and what happens in markets, looking at data can show whether you're crazy or not. We don't think we're crazy for thinking markets need to go meaningfully lower. And we're studying the data to figure out if and where we could be wrong.
Let's look at the week ahead:
Starting with earnings reports, we have a good mix this week.
It would be great to get net short exposure on equities down to 10% after the next drawdown. Pushing shorts further on any rallies seems rational. Though investing in a market that won't fall is like walking on thin ice - it's all fine until one step causes a crack and next thing you know you're drowning in the frozen water.
Finding more long positions has been difficult. On the list right now are tech companies with low leverage and high dividend yields, a small group of U.S. utilities that can grow earnings without growing customer bills, gold/silver miners, and adding to existing positions.
The list of short ideas includes retail, restaurants, hotels, home builders, banks, real estate, manufacturers, oil producers, and more.
If U.S. Treasury yields rise, we'll add to EDV and TLT this week. If they spike, ZROZ will join the fold.
Gold is a position we max out at 10%, so it would take some real weakness to add more. Similarly, it would take a big gold rally to make us sell.
That's it for this note. We'll be out tomorrow morning with our Daily Note. As always, drop a comment below with your best ideas and anything else you want to share.
Good luck out there.
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