Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

DELEVERAGING

THE DAILY EDGE: 8 JUNE 2020: R20 Strategy Raises Cash

Jobless-Rate Drop, Payroll Gains Signal a Mending Economy. The May U.S. jobless rate fell to 13.3% and employers unexpectedly added 2.5 million jobs, early signs the labor market is mending. The jobless rate fell from 14.7%, which was the highest on records dating from 1948.

Employment remained down by nearly 20 million jobs, or 13%, since February, the month before the pandemic prompted states to shut down huge segments of their economies. By comparison, the U.S. shed about 9 million jobs between December 2007 and February 2010, a period that covered the recession caused by the financial crisis. (…)

Restaurants and bars added 1.4 million workers last month—more than half the overall job gain—as new virus infections eased and many states began lifting shutdown orders. Other industries adding workers included construction, health care and retailers—among the industries that had been quickest to let go of workers in March and April. (…)

While 21 million workers remained unemployed last month, research suggests that more than half of those laid off during the pandemic are earning more than they did at their jobs, thanks in part to stimulus checks and extra $600 a week in unemployment pay approved by Congress.

“People have been cooped up in houses and apartments for weeks and they’re anxious to get back,” Mr. Sohn said. “They have money to spend—disposable income.” (…)

In May, a broader measure of unemployment—including jobless workers, those working part time and those who have given up the job search because they are too discouraged—stood at 21.2% in May. Many other workers have taken pay cuts. Gregory Daco, chief U.S. economist at Oxford Economics, estimates that at least half of the workforce has lost a job, lost hours or took a pay cut. (…)

fredgraph (89)

More than 80% of the people who lost jobs during the pandemic expect the loss to be temporary.

Those permanently separated from their jobs totaled 3 million in May, a low level compared with prior downturns. In October 2009, when unemployment peaked after the financial crisis, there were 8.3 million such workers. (…)

Nearly 90% of Fiat Chrysler Automobiles NV’s hourly factory workforce in North America has returned to work, the company said in a statement. (…)

Forecasting firm Moody’s Analytics projects the unemployment rate will fall to 8.5% by year-end and that the annual job loss will settle at 8 million. (WSJ)

(…) The jobs report is subject to revisions, however, and given the difficulties with collecting data in the midst of the Covid-19 crisis, and the sheer scope of the economic disruptions it has caused, those revisions could be enormous. For example, the Labor Department reported that the response rate in the survey it uses to calculate the unemployment rate was just 67%—about 15 percentage points lower than it was before the crisis struck. Unemployment among the people that the Labor Department isn’t reaching is probably higher than it is for the people to whom it can get through. (…)

Pointing up At the very end of the footnote to its release, the BLS warned:

However, there was also a large number of workers who were classified as employed but absent from work. As was the case in March and April, household survey interviewers were instructed to classify employed persons absent from work due to coronavirus-related business closures as unemployed on temporary layoff. However, it is apparent that not all such workers were so classified. BLS and the Census Bureau are investigating why this misclassification error continues to occur and are taking additional steps to address the issue.

If the workers who were recorded as employed but absent from work due to “other reasons” (over and above the number absent for other reasons in a typical May) had been classified as unemployed on temporary layoff, the overall unemployment rate would have been about 3 percentage points higher than reported (on a not seasonally adjusted basis). However, according to usual practice, the data from the household survey are accepted as recorded. To maintain data integrity, no ad hoc actions are taken to reclassify survey responses.

Pointing up Pointing up And, as pointed out by David Rosenberg:

Businesses were incentivized to hire back their workers in May in order to meet the requirements under the $660 billion Paycheck Protection Program — as in, having
the loans shift to grants so long as staff levels were maintained.

David also

noticed that there were actually 295k more people who lost their jobs permanently in May, bringing the cumulative tally over the past three months to over one million — we last saw this at the depths
of the 2008/09 Great Recession. And the BLS’s own probability measure of re-employment is only 38%, so we’ll see what sort of
follow-through we get in the months ahead.

Bloomberg:

(…) “High frequency data — including mobility stats and small business openings — have been pointing to a trough in economic activity since mid-April,” Jefferies economists Aneta Markowska and Thomas Simons said in a note to clients. “Jobless claims did not fit with that picture, suggesting there was no positive follow-through to the labor market. We now know that claims were wrong. The May employment report was rock solid, with broad-based gains across many industries.” (…)

But claims cannot be wrong. And they are still rising, even if at a “slower” pace of +2.1M (!) on average in the 3 weeks since May 9, the week of the BLS survey.

fredgraph (90)

Markit’s May PMI surveys cover data collected 12-28 May 2020, so after the BLS survey. From the Services PMI survey:

Reflecting weak demand conditions, service sector firms reduced their staffing numbers at a significant rate in May. The rate of job shedding was faster than any other seen before April, as lower new business inflows led to greater excess capacity. Another monthly slump in total sales also drove a further depletion in outstanding business.

From its Manufacturing PMI survey, same dates:

Despite  efforts to adapt using reduced working hours and furloughing  staff, firms cut their workforce numbers at the second-quickest rate in over 11 years.

Markit also publishes a Sector PMI covering over 1,000 private sector companies:

The latest survey data, collected 12-28 May, pointed to a steep downturn across all areas of the US private sector economy with the exception of healthcare. But all sectors display negative employment diffusion indices, indicating that many more firms are reducing employment than there are increasing it.

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Lastly, the BLS report reveals that private service sector hours increased to a record 33.8. I truly wonder how solid that stat can be when most services are shut or operating with most employees working from home.

That said, Canada had a similar surprise as the Globe and Mail writes:

In Canada, the number of employed people rose by 289,600 last month as provinces began to reopen their economies, Statistics Canada said Friday, or strikingly better than a loss of 500,000 that economists had expected. The unemployment rate climbed to a record high of 13.7 per cent as more people rejoined the labour market in search of work.

Indeed, with May’s increases, Canada has recouped just less than 10 per cent of a combined three million jobs lost in March and April, while the U.S. has recovered 11.4 per cent of 22 million positions lost during those months.

Over all, there are still close to five million Canadians who either lost their jobs or the majority of their work hours because of the pandemic.

Markit’s Canada PMI;

(…) employment numbers continued to decrease at much a faster pace than at any time prior to the COVID-19 pandemic. Around 40% of the survey panel reported a decline in staffing levels, while only 9% signalled an increase.

Time will eventually tell but I sense we should be careful with this positive May employment report

The real key to the recovery will come from demand statistics. Fathom Research:

Looking at some of the dramatic falls in consumer debt statistics across the world, the COVID-19 pandemic has all the hallmark of one great, orderly and synchronised global consumer deleveraging.

Reuters Graphic

“Consumers are placing a greater focus on essential spending categories,” Fitch Solutions said in a June 4 report, predicting a fall in Chinese household spending this year and slashing its 2020 growth forecast to just 1.1% from 5.6% before the pandemic.

In the United States, commonplace brands such as chocolate giant Hershey or toothpaste-maker Colgate say consumers have traded down.

French Labor Minister Muriel Penicaud said the economy is running at 80% of normal. Speaking on France Info radio, Penicaud said industry is running at about 60% of normal and that the long-term furlough program being discussed by unions could last for as long as two years.

Citing the risk of cash-hoarding, French Finance Minister Bruno Le Maire has called for direct incentives to boost demand.

“Overall, the (ECB) Governing Council sees the balance of risks … to the downside.”

Opec output curbs spur US shale to ramp up production Operators poised to reactivate wells after cartel’s success in reviving prices

VIRUS UPDATE
  • California, Some Other States See Virus Cases Rise Nearly three months since the U.S. declared a national emergency over the new coronavirus, some states are reporting a rise in new cases as they lift restrictions meant to slow the virus’s spread.
  • The virus continued its surge through Brazil, which reported more than 1,000 new fatalities, and Mexico, where the death toll at state-owned oil company Petroleos Mexicanos alone exceeds 100.
  • Worldwide infections from the coronavirus surpassed the 7 million mark, a little more than a week after reaching 6 million cases. The global pandemic is hitting such milestones faster as hot spots including Brazil and India drive a daily increase of more than 100,000 cases.
  • Iran President Hassan Rouhani pleaded with the public to take social distancing more seriously following a record jump in cases. Russia, the country with the third-highest number of diagnoses, reported a 2% daily increase. Infections in India surpassed those of Italy.
  • Indonesia reported a record increase in new coronavirus cases, taking its total number of infections to more than 30,000. The country had its largest daily increase as diagnoses spiked by 993 on Saturday. The record number of new cases comes as the nation’s capital Jakarta is set to ease restrictions put in place to counter the spread of the pandemic, with authorities pushing to reopen Southeast Asia’s biggest economy.
It’s Covid Code Red in Latin America With No Signs of Peaking

The number of regional cases just passed 1.1 million. Demographic giants Brazil and Mexico are posting among the fastest growth rates and logging daily death records. Viral illness is also rising in Peru, Colombia, Chile and Bolivia.

“The curve is steepening — the sky is the limit,” Julio Croda, an infectious disease specialist and former Brazil Health Ministry official, said about the trajectory in his home nation. “The current data show no signs of stabilization.” (…)

Latin America, with its 650 million inhabitants, is now a grim laboratory of viral pandemic. (…)

New Evidence Social Distancing Is on the Wane Data show that only a third of the public is now staying at home all day.

Fathom Research:

(…) a V-shaped recovery chiefly requires having learned some key lessons as the risks of a second wave seem to have also risen over the past weeks. In the absence of a vaccine, the experiences of Korea, Taiwan and Japan unequivocally show that the quick and effective implementation of track-and-trace measures is significantly more effective and efficient than economy-wide shutdowns, but rely on a highly effective bureaucratic apparatus. Attitudes to the virus seem increasingly complacent and primarily based on reports that Wuhan has not seen any new meaningful increase in infections. Indeed, new lockdown measures have been reported in Northern China in late May and seemed to have normalised since. Korea has also recently successfully quashed new localised virus hotbeds.

The recent experience from Iran is far more sobering and perhaps more pertinent to much of the western world. It has been reported that, this past weekend, the Iranian government let all state employees back to work, allowed mosques to hold daily services and removed most restrictions on businesses. This was against healthcare advice and without a track-and-trace programme in place. As of Tuesday, the health ministry reported almost the same number of new infections as at the country’s peak in late March. Saudi Arabia could be another country to keep an eye on over the next weeks as it allowed mosques to reopen for daily services. (…)

Equally importantly the recent experiences in Singapore and across Europe have highlighted how differences in the economic fabric of different countries are important determinants of a country’s susceptibility to the virus and the associated economic fallout. A recent report from the World Bank, for example, analyses differences across countries in the proportion of jobs that can be carried out from home. The spread between countries is striking as is the heterogeneity among European countries. It is also interesting to see how both the UK and the US do not feature anywhere near the top countries with a high share of jobs that could be performed from home. Yet, both have been among the more relaxed among developed markets in their efforts to curtail the virus.

Pointing up THE RULE OF 20 STRATEGY RAISES CASH

At 3200 last Friday, the Rule of 20 P/E reached 21.6 which triggered an increase in cash from 30% to 40%.

TECHNICALS WATCH

Obviously, Mr. Market is not focused on trailing earnings. Actually, not even on forward earnings, at least those prior to 2022.

Lowry’s Research has been remarkably good calling the momentum through its research on Supply/Demand. After Friday’s close, Lowry’s commented that “At present, despite the various unsavory story lines, the trends in the forces of Supply and Demand are healthy and increasingly supportive of the market advance.”

Its analysis concludes that not only have sellers withdrawn, buyers have returned “enthusiastically”. “Despite its simplicity, the story of Supply and Demand, reinforced by robust breadth, tells investors all they need to know. Not only is the market advance healthy but it continues to strengthen as the price indexes climb – opposite of trends in vulnerable rallies.”

Yes Virginia, momentum feeds momentum, until it doesn’t.

I have never given a lot of weight to technical analysis in my asset mix decisions, until I discovered Lowry’s Research a few years ago. Their method, focused on intelligently measured supply and demand trends makes sense.

I have, however, always payed heed to the 200-day m.a. as an important, albeit not critical, indicator of the basic longer term trend. The fact that the S&P 500 Index has crossed above its now rising 200dma troubles the fundamentalist in me. Even more so since the equal-weight SP500 has now done the same.

And now, this chart is threatening to give a bullish signal as well:

And cash can’t even buy popcorn at the movie, even if we could go to the movies.

Still, this market has bounced on hopes is being valued with normalized data in a truly abnormal world fraught with significant uncertainties.

My friend Terry sent me a piece in Business Insider about “risk velocity” which quoted Seema Shah, chief strategist at Principal Global Investors. Excerpts:

  • “Markets are once again vulnerable to a negative swing in sentiment – certainly a second wave of infection that results in renewed lockdowns could bring this new bull market to an abrupt end,” she said.
  • The past decade’s rise of social media platforms formed “a global echo chamber to major, anxiety-inducing events,” Shah said. This trend accelerated the spread of coronavirus fears around the world and, accordingly, “exacerbated a collapse in both investor and household confidence,” she added. Unfortunately for bullish investors, the opposite is unlikely to take place. Investors and the general public alike will run into a great deal of misinformation as the virus threat abates and economies reopen, making the proliferation of social media a strong headwind against a broad market recovery.
  • “Global supply chains mean that the world economy will only be as strong as the weakest link,” Shah wrote, adding global growth and markets “may be the ultimate losers.”
  • “Even tech giants aren’t fully immune to the negative impact of COVID-19, and a disappointing earnings result from any one of them risks reversing recent US equity gains,” she wrote.

From Barron’s:

Insider Transactions Ratio
PANDEMONIUM

Trump Threatens New EU, China Tariffs Over Lobster in Maine Trip

President Donald Trump threatened to impose tariffs on cars made in the European Union and on unspecified Chinese products unless the trading partners reduce their duties on U.S. lobster.

“If the European Union doesn’t drop that tariff immediately, we’re going to put a tariff on their cars, which would be equivalent,” Trump said in a roundtable event in Bangor, Maine, with commercial fishermen and the state’s former Republican governor, Paul LePage. “It’ll be the equivalent, plus,” he added. (…)

Danger ahead: US bumps in China’s global belt and road 
  • Beijing’s ambitions to link countries and continents through infrastructure have hit a hazard in Romania, with Bucharest abandoning plans for a joint nuclear energy project
  • American pressure could mean a rethink in strategy for other small allies that do business with Chinese partners, observers say

THE DAILY EDGE: 29 MAY 2020: Dealing With Uncertainty

  • 88. The U.S. hit a grim milestone this week when it surpassed 100,000 confirmed coronavirus deaths. I realize “time” is a squishy concept, but it’s important to note the U.S. went from zero to 100,000 in just about 88 days, calculates Fortune‘s Lance Lambert. Few countries have managed the outbreak well. Most days it seems like we’re looking at a game of whack-a-mole where hotspots smolder and cool off, only for new hotspots to emerge. According to the New York Times, the number of infections and deaths are rising in more than a dozen states. The stock markets may be soaring, but this public health crisis is far from over. (Fortune)
PANDENOMICS
Easing Unemployment Claims Show Slower Pace of Coronavirus-Related Layoffs

Initial claims for unemployment benefits declined to a seasonally adjusted 2.1 million last week from 2.4 million the prior week, the Labor Department said. The level of claims is still 10 times prepandemic levels but has fallen for eight straight weeks.

Meanwhile, the number of workers receiving jobless payments for the week ended May 16 was 21.1 million, down 3.9 million from the prior week. The level remains well above the record before this year—6.5 million in 2009—and underscores that tens of millions remain jobless. (…)

Employees reported for 17% more shifts for the seven days ended May 24 than they did six weeks earlier, when job activity bottomed out, according to Kronos, a Massachusetts workforce management software company.

And some firms have begun hiring. Job search site Indeed.com said job postings have increased during the past three weeks, though the total is still down 35% from a year earlier.

Companies are also bringing back workers to qualify for government loan forgiveness, though some have warned they may need to lay off employees again when that support runs out. (…)

Many economists say it will take many months, if not years, to replace all the jobs lost this spring. Forecasters at the University of Michigan project the pandemic-related shock will result in about 30 million total jobs lost, with about a third of those returning this summer. (…) (WSJ)

U.S. GDP Decline in Q1’20 is Deepened; Corporate Profits Plunge

U.S. GDP declined 5.0% (SAAR) last quarter, revised from -4.8%, following a 2.1% Q4’19 rise. An unrevised 4.8% fall had been expected in the Action Economics Forecast Survey. (…)

After-tax corporate profits without IVA & CCA declined 16.0% (-11.1% y/y) with the decline in business activity. Profits with IVA & CCA fell 13.9% (-8.5% y/y). Nonfinancial sector profits were off 11.9% (-5.2% y/y) while financial profits declined moderately. Foreign sector profits fell 10.8% (-3.2% y/y).

Domestic final sales was shaved to 4.8% last quarter from -5.4%. The decline was lessened as the consumer spending fell 6.8% (+0.6% y/y), revised from -7.6%. (…)

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STR data ending with 23 May showed another small rise from previous weeks in U.S. hotel performance. Year-over-year declines remained significant although not as severe as the levels recorded in April. (…) “What was also noticeable in the week’s data was the higher occupancy levels across all classes of hotels. Economy properties continued to lead, but we also saw the higher-priced end of the market up over 20%. Regardless, Upper Upscale occupancy continues to lag the broader industry as meeting demand is still not returning.” (…) (Chart from CalculatedRisk)

Americans Have Stopped Thinking the Economy Is Getting Worse

This is from recent survey data that Democracy Fund/UCLA Nationscape shared with Bloomberg Businessweek. The survey asks more than 6,000 people each week whether the economy is better, worse, or about the same as a year ago:relates to Americans Have Stopped Thinking the Economy Is Getting Worse

But it only stopped getting worse, at a very low level. Gallup:

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Banks report uptick in credit card spending, loan activity as consumers loosen pandemic purse-strings

(…) Consumer spending and loan origination has rebounded to varying degrees over the past two months. Bank of Nova Scotia saw total consumer spending fall by 35 per cent in mid-March, then steadily improve since the beginning of April. Spending is now just 4 per cent below prepandemic levels, according to Daniel Moore, chief risk officer at Scotiabank.

National Bank, meanwhile, saw weekly mortgage originations drop by 50 per cent, year-over-year, in early April, and auto lending plummet 80 per cent. Both segments have rebounded in recent weeks, and are now 5 per cent and 35 per cent below last year, respectively.

Over the course of the pandemic, spending patterns have varied by sector, said Neil McLaughlin, Royal Bank of Canada’s head of personal and commercial banking. RBC clients spent about 50 per cent less at restaurants in the quarter, which ended on April 30, but spent about 20 per cent more at grocery stores and pharmacies, he said.

“Net for the quarter, we were down about 12 per cent or 13 per cent in terms of spending. … There’s about $5-billion of purchase volume that we had anticipated that did not materialize because of the COVID measures,” Mr. McLaughlin said on a Wednesday conference call.

Across all of the big banks, credit card balances have come down. Likewise, lines of credit, which were drawn down heavily in March, are starting to be repaid. (…)

Taken together, the Big Six banks have deferred payments on more than $200-billion worth of mortgages, personal loans and credit cards. The payment holidays range from one to six months. What will happen at the end of this deferral period remains the biggest outstanding question for bankers and policy makers alike.

  • Europe inflation dropped further to 0.1% as the decline in the oil price continued to work its way through to petrol prices in May. The decline in energy prices was -12% YoY, which far outweighs the somewhat higher unprocessed food inflation of the lockdown. Core inflation has remained surprisingly stable at 0.9%, which might have been influenced by the difficulty in gathering data gathering during the lockdown period. (ING)
  • The aviation industry’s recovery from the coronavirus outbreak will be long and slow, with passenger numbers likely to stay below pre-pandemic levels through 2023, according to S&P Global Ratings, which warned of more rating downgrades for airports over the next few months. Global air passenger numbers will drop as much as 55% this year, a far steeper slump than previously estimated, analysts including Tania Tsoneva and Julyana Yokota wrote in a report dated May 28.
  • CN lays off 5,800 as rail traffic, economic demand fall
  • Renault SA plans to eliminate about 14,600 jobs worldwide and lower production capacity by almost a fifth as part of cost reductions aimed at outlasting the downturn that has rocked the global auto industry. The plan includes cutting almost 4,600 positions in France, or about 10% of the carmaker’s total in its home country, through voluntary retirement and retraining, according to a statement Friday. More than 10,000 further jobs will be scrapped in the rest of the world, trimming a global workforce of about 180,000 people.
  • Volkswagen Pours More Than $2 Billion Into China’s Electric-Car Industry Volkswagen is raising its share in a Chinese electric-vehicle joint venture and buying 26% stake in a local battery producer.
Our Exploding National Debt – How Will It Be Managed Post-Covid?

This is from Haver Analytics’ Paul Kasriel:

(…) Before the COVID-19 pandemic hit, the US was facing a federal fiscal environment that, according to the CBO, was on a course to push the ratio of federal debt to GDP above the 1946 high. (…) The forecast shows that in 2037 federal debt as a percent of nominal GDP is forecast to surpass the previous high of 106% set in 1946 and continue higher through the end of the forecast period. (…)

Given that we will soon be at or above WWII levels of national debt relative to GDP, it might be instructive to review how the debt-to-GDP ratio was brought down after the war. (…) For starters, the federal government ran small budget deficits relative to nominal GDP. Chart 4 shows that the 20-year moving average of the federal budget deficit as a percent of nominal GDP reached a post-WWII minimum of 0.1% in fiscal year 1966. How did the Treasury accomplish this narrowing in its budget deficit relative to nominal GDP?

For starters, personal federal income-tax rates were raised in 1942 after the breakout of WWII and stayed above their pre-war levels until 1964 (see Chart 5). So, income-tax rates remained high in order to generate revenues to help narrow the Treasury budget deficit. In addition to keeping marginal income-tax rates high, Congress showed restraint in federal spending. As shown in Chart 6, the annualized growth in federal outlays slowed to a post-WWII low rate of 1.2% in the 20 years ended 1965.

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When WWII broke out, the Fed entered into an agreement with the Treasury to peg the yields on Treasury bills and bonds. The Fed pledged to keep the interest rate on 3-month Treasury bills from rising above 3/8% and the yield on Treasury bonds from rising above 2-1/2%. Around midyear 1947, the Fed stopped pegging the rate on Treasury bills. In March 1951, the Fed reached an “accord” with the Treasury to stop pegging the yield on Treasury bonds.

Pegging the yields of Treasury securities at low levels helped restrain the cost of servicing the massive amount of debt outstanding. But it also required the Fed to purchase large amounts of securities in order to enforce the interest-rate pegs. This manifested itself in rapid growth in the money supply. All of this is shown in Chart 7. The rapid growth in the money supply during WWII under normal circumstances would have resulted in high inflation. But from early 1942 through the spring of 1946, the federal government imposed controls on prices. But, as shown in Chart 8, after the lifting of price controls in the spring of 1946, the prior rapid growth in the money supply resulted in a sharp increase in consumer-price inflation in 1947.

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Speaking of inflation, that is another method to bring down the federal debt-to- nominal GDP ratio. It sure worked wonders during the 1970s and early 1980s in bringing down the federal debt-to-nominal GDP ratio, as shown in Chart 9. If the central bank creates higher inflation, this boosts nominal GDP. Thus, for a given amount of federal debt outstanding, the ratio of debt to GDP falls. But won’t higher inflation increase interest rates because of the expected-inflation premium? And won’t that result in an increase in debt issuance due to the higher debt-servicing costs?

Higher inflation will raise those interest rates on maturities of securities the central bank is not pegging. For example, if the central bank is pegging interest rates on short-maturity securities, then interest rates on longer-maturity interest rates will rise in reaction to the higher inflation. The government need not incur higher debt-servicing costs if it refunds maturing debt and issues new debt in the short-maturity range. Alternatively, the central bank could peg interest rates at the long end of the maturity spectrum. Then the government would finance maturing and issue new debt at the long end of the maturity curve.

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I don’t know how the Treasury is going try to prevent the national debt-to-GDP ratio from exploding ever upward once the COVID-19 epidemic is over and the economy is in a strong recovery phase. Perhaps there the body politic will accept some tax increases. But there was no appetite for that before COVID-19. Certainly the COVID-induced safety-net spending will be cut. But the primary drivers of post-COVID spending will be Social Security and Medicare. Do you think we Baby Boomers will vote for that? Perhaps COVID will take enough of us Baby Boomers out so there will be a reduced supply of Social Security and Medicare beneficiaries, but don’t bet on it.

That leaves us with inflation, the silent tax, coming on the heels of the silent COVID-19 “enemy”. In the past 20 years, the median percent change in the annual average CPI (all items) has been 2.2%. My bet is it will be higher than 2.2% over the next 20 years? My bet also is that the level of interest rates, other than the maturity sector the Fed pegs, will be higher than what we have become accustomed to in recent years. Equities might have some competition.

Mr. Williams said the Fed’s support actions, which have boosted its balance sheet to just over $7 trillion from $4.2 trillion in early March, are aimed at bridging the economy over the crisis and aren’t a form of outright stimulus. (…)

Mr. Williams also pushed back at any notion the Fed was looking to use negative interest rates as a stimulus tool during the current troubles, saying such a policy wasn’t right to address the challenges facing the nation.

For now, the governments’ and central banks’ bridges are preventing a depression. But much buying power and demand will have been destroyed for good. The output gap will remain large for a while.

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DEALING WITH UNCERTAINTY

Goldman’s David Kostin sees five key drivers that powered the rally:

(1) A series of critical monetary policy initiatives by the Fed; (2) massive fiscal stimulus by Congress; (3) a bending of the viral curve in the US; (4) a narrow group of large-cap stocks that lifted the cap-weighted index while the typical stock lagged; and (5) optimism about the restart of the economy. (…)

Items 1,2,3 and 5 removed the extreme fear that peaked March 23rd. Item 4 provided some fundamentals to buy certain stocks/sectors and created general momentum. Just in the past two weeks, the Nasdaq tech-heavy index rose nearly 5%, pushing it into positive territory for 2020 (4.4% higher YTD). Essentially more of the same since 2013. Per Ed Yardeni’s numbers:

Since 2013:

  • S&P 500 Index: +192% (+9.1% annually); earnings +125% (+3.0%)
  • FANG stocks: +734% (+30.4%); earnings: +653% (+28.4%)
  • S&P 500 ex-FANGs: +173% (+7.6%)

Kostin continues:

Our baseline 2021 EPS forecast of $170 represents a best-case scenario — achievable, but definitely optimistic. Current valuation based on our macro model implies business steadily normalizes. If these developments transpire, at year-end 2020 the S&P 500 will be trading at 18x our 2021 EPS estimate and 20x buy-side expectations. The risk of an economic, earnings, trade, or political hiccup to normalization means near-term returns are skewed to the downside, or neutral at best. (…) Monetary and fiscal policy support limit likely downside to roughly 10% (2750).

Q2 earnings are seen falling $18 YoY which would take trailing EPS down to $140 at the end of August. If inflation is stable at 1.4%, the Rule of 20 P/E would be 21.1 at 2750. It troughed at 15.9 in March.

One can also wonder how long item 4 above will continue its momentum. Still using Ed Yardeni’s data and charts:

Forward P/Es:

  • S&P 500 Index: 13.0 in 2013, 21.2 on May 21
  • S&P 500 ex-FANGs: 12.5 in 2013, 19.4 on May 21

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FANG stocks were selling at 60x forward earnings in 2013, now 62.5. Since 2016, they have not sold at more than 60x and since 2019 rarely more than 50x.

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However the pandemic helps their respective businesses going forward, these 4 companies are now very large, challenging their capability to keep growing at the same lightspeed rates (next charts via Morningstar/CMPS):

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And its not like if their EPS have been keeping pace with sales:

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Their net margins are generally in a downtrend:

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All this to say that the FANGs’ current high momentum and expectations (valuations) are not without fundamental risks.

Rosenberg: This is when the stock market rally is likely to unravel – and it’s not going to be pretty

(…) We know what the market has priced in and what it is willing to ignore. If there is no vaccine success by the end of the summer, risk assets will have a very tough time with that, and what I now call the “benefit of the doubt” rally will peter out and roll over.

We have to tack on the added complication of a U.S. election in November. Donald Trump is trailing badly in the polls, even in some of the key battleground states, and I see in the betting markets that the Senate is now a toss-up. The market is not looking that far out, but I can tell you that a Democratic sweep would not be good news for capitalism or the stock market, and while top marginal personal, corporate and capital-gains tax rates won’t go up immediately, they will be going up at some point. All the portfolio managers who are bullish today because they don’t see the current situation as impairing the long-run normalized earnings curve will undoubtedly have to start making some permanent downward adjustments to that curve on an after-tax basis. (…)

Speaking of polls:

  • Prediction markets currently assign a 78% probability the Democrats control the House of Representatives, a 51% likelihood of occupying the White House, and a 48% probability of controlling the Senate.
  • President Donald Trump’s prospects of winning a second term in office will be closely tied to the level of his job approval rating. Historically, all incumbents with an approval rating of 50% or higher have won reelection, and presidents with approval ratings much lower than 50% have lost.
  • Trump, like his two immediate predecessors, has approval ratings in the mid-to-upper 40% range, which indicates his reelection is uncertain. Thus, even a modest increase or decrease in his approval ratings significantly alter his odds of winning a second term.

To sum up, we need to acknowledge that, at this particular moment, more than most other moments, we know nothing about the immediate and intermediate future: Covid-19, economy, finance, revenues, margins, profits, elections, etc., etc…

Oaktree’s Howard Marks wrote about uncertainty a few weeks ago and again yesterday:

Since we know nothing about the future, we have no choice but to rely on extrapolations of past patterns. By “past patterns”, we mean what has normally happened in the past and with what severity. (…) How can we prepare for something if we can’t predict it? Turned around, if the greatest extremes and most influential exogenous events are unpredictable, how can we prepare for them? We can do so by recognizing that they inevitably will occur, and by making our portfolios more cautious when economic developments and investor behavior render markets more vulnerable to damage from untoward events.

This is where the Rule of 20 helps most. We know more about the present than about the future. At least, we know where valuations currently stand and we know how they fluctuate, almost inevitably:

image

  • We know valuations are on the high side.
  • We know that earnings will keep falling throughout 2020, making current valuations on trailing EPS even more expensive on future EPS.
  • We know a full-V-shape recovery carries very low odds.
  • We know about the enormous debt overhang building up.

What we don’t know:

  • timing for medicine/vaccine availability on a large scale.
  • inflation/deflation?
  • elections?

We know this is not “buy-low” time and that risk management is paramount. We know we can prepare.

13/34–Week EMA Trend: (CMG Wealth)

WHO FEARS ZOMBIES!

From STA Wealth Management:

The chart below from Arbor Data Science illustrates strong stock market returns during the recent rebound for companies that have had a low EBIT/Interest expense ratio over the last three years.

Ned Davis Research calculated that 36% of Russell 2000 companies were unprofitable in 2019. Q2 EPS for the Russell 2000 Index are expected to be down 95% and Credit Suisse says that  

35% of Small Caps are expected to lose money in 2Q, versus just 15% for Large. EPS growth is
expected to lag Large Caps across all major groups with the greatest differences in Health Care
(51% vs. 12% losing money) and TECH+ (36% vs. 7%).

So small caps’ earnings are cratering at twice the rate of large caps’. Yet:

iwm

Mug Martini glass BAR NONE?

Barry Ritholtz recently interviewed Jon Taffer (Bar Rescue):

So by effect, the regulations to open a restaurant has closed the bar. Now you can order a drink at your table, but the bar itself is closed for walk-up or sit-down customers. (…) So the bar industry is far more challenged than the restaurant industry is. And I’m very concerned we’re going to lose about 40 percent of them.

JP Morgan agrees

High-traffic, destination oriented, bar-focused businesses without
drive-throughs or meaningful delivery (below 10% of sales) will
likely have the most difficulty recovering previous peak customer
counts.

But, well, don’t count American solidarity out just yet:

Cheers!

Contact: edgeandodds [at] gmail.com