4/10/20 – Strong Week Sees Stock Diverge from Economy

Markets were closed today in observance of Good Friday. I hope you all have as good an Easter week as possible given the current situation. Another 6.6 million people filed initial jobless claims this week. That brings the three week running tally to over 16 million claims. To put that into perspective, the total number of people employed peaked at just under 159 million people in January. That means, in three weeks, over 10% of employed people lost their job and filed for unemployment insurance. That number is going to keep rising in the coming weeks as the shutdowns continue. Over 90% of the US population is under stay-at-home orders meaning all manner of economic activity isn’t happening. The ripple effects and ramifications of this will be felt for many quarters, potentially years. And yet the stock market is rallying and back to levels seen in early 2019, when the general outlook on earnings and economic growth was substantially better than it is today.

What is going on? The US economy is roughly $22 trillion. Between Congress and the Fed, there is roughly $4.5 trillion of stimulus coming. That’s 20% of the economy. That’s roughly double the stimulus during the financial crisis, so that’s an enormous boost to capital markets. But will that keep the economy afloat? Zeke Emanuel, a key architect of Obamacare and current special advisor to the World Health Organization said we need to stay in some form of shut down for another 18 months, “The kind of normal where we go traveling, we go to restaurants, we go to concerts, we go to religious services, we go on cruises, until we have a vaccine that protects everyone. That’s 18 months, it’s not going to be sooner.” That’s terrible for the economy. The National Association for Business Economics did a survey over the last week of economists and the consensus was ~50% of the jobs lost won’t be regained until after 2021. This level of unemployment will hurt almost every aspect of the economy. So, we have the economy in a severe slowdown and the Fed/Government trying to print/borrow enough money to bridge the gap. That’s possible to do if this lasts for another few weeks or even few months. It’s not possible in my opinion, if we’re on some sort of social distancing and non-normal plan through the end of 2021. Stocks are ultimately priced off earnings and if earnings are down over the next 18 months, I believe stocks have to follow suit.

There’s a chance with increased antibody testing, we’ll find that many more people have already had the virus. We hope that having had it provides some medium to long-term immunity like other viruses. We don’t know if the antibodies will protect people from slight mutations of the virus. There’s also a chance we can’t develop an effective vaccine in 18 months. There are points of optimism and points of concern. I scaled into some new positions this week, but remain comfortable holding a larger than normal cash balance. What I’d love to see is a full week of relatively calm days. Seeing the market move up/down 2%+ on a day, in a large, developed economy, still tells me that no one really has any solid outlook for what the next 6-12 months hold. For the week, the Dow gained 12.7% while the S&P 500 increased 12.1%. Both remain 18-20% below their peaks.

Oil decreased sharply this week, continuing its volatile run, declining 20.4% to close at $22.73/barrel. The yield on the 10-year Treasury increased to close at 0.73%, from 0.61% last week. The average rate on a 30-yr fixed rate mortgage held steady at 3.33%.

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4/3/20 – Stocks Down as Virus Fear Spreads

It’s hard to imagine saying a week that saw the Dow decline almost 3% felt reasonably calm, but it’s true. While markets continued to sell-off, we didn’t have any days where the Dow moved up/down by over 1,000 points. Over the past five weeks, each week saw at least two days where the Dow was up/down more than 1,000 points. Every day of the week of March 9th moved by over 1,000 points. Prior to late-February a down 3% week felt terrible, now it feels like a sigh of relief. For the week, the Dow declined 2.7% while the S&P 500 decreased 2.1%. I still think we’re in a downward trend, but this week felt more orderly than anytime since mid-February.

We’ve known for several weeks that the lockdowns and protective measures put in place across large swaths of the country would hurt economic growth. We got more early data on how severe the impact will be. This week, 6.6 million initial jobless claims were filed. This is on top of 3.3 million filed last week. That’s 10 million jobs in two weeks. The March jobs report came out today and showed a loss of 701k jobs in the month. That misses a lot of the job loss late in the month and April will be a brutal month for job losses. It’s conceivable we’ll see 10mm+ job losses in April and the unemployment rate shoot past 10%. On economic growth, various wall street firms have published estimates showing the economy will contract ~30% in the 2nd quarter. The real issue is when will it rebound. Some think the 3rd quarter will see a rebound, while others believe it won’t happen until the 4th quarter. My current projections are for 4th quarter at the earliest, which will significantly hurt earnings for most major companies. It makes valuing companies in this market challenging. Stocks are valued off a multiple of future earnings and cash flow. Right now future earnings and cash flow are near impossible to project.

Over the next two weeks, companies will start reporting 1st quarter earnings and I think we’re going to see many companies pull forward earnings guidance because there’s no way to accurately assess what the future holds. I expect some companies will suspend share buybacks and cut dividend payments.  We’ve seen/heard lots of bad economic data over the last couple weeks, but hearing from companies will provide great insight to what is happening on the front lines of the economy and give us a sense for how bad this recession is going to be.

On the virus front, confirmed cases continue to grow at high rates. There are currently 270k confirmed cases in the US. This is up from 100k cases last Friday. That’s doubling approximately every 4 days, even with all these protective measures. There’s been some positive headlines on vaccine development and some potential treatments, but all of those are speculative and months away, at the earliest. The key for any treatment as well is that it needs to be able to reduce or eliminate hospital stays. Decreasing the mortality rate is great for our country, but reducing the hospitalization rate is key for getting the economy started sooner.

Oil climbed sharply this week on rumors that Russia and Saudi Arabia will cut production. Oil inventories are bloated, demand is down and producer countries have to agree to cut production if they want to support the price. For the week, oil increased 32.2% to close at $28.56/barrel. The yield on the 10-year Treasury decreased to close at 0.61%, from 0.71% last week. The average rate on a 30-yr fixed rate mortgage declined to 3.33% from 3.50% a week ago.

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3/27/20 – Strong Week Ends on Down Note

The subject says ‘Weekly Recap’ but last Friday feels like a month ago to me. The market followed up last week’s horrible week with a strong rally, although stocks sold off today, closing near session lows and declining 700 points over the last 20 minutes. Even with the rally this week, I continue to believe we’re still in a downward trend. I don’t think there’s much chance that people will start going back to work until May at the earliest and potentially after that. The economy likely shrank in the first quarter, will definitely shrink in the 2nd quarter and the 3rd quarter will be dependent on how fast we can get people back to work on a regular basis. Even when we return to work, it seems likely cases will start picking up again and we could end up in a rolling lockdown situation through the end of the year. The reality is no one really knows. The market’s activity supports that. Over the last 25 trading days, 21 days have moved up/down by more than 2%; with an average daily move of +/-5%. That’s unheard of for a $22 trillion economy.

The optimistic view is many more people have already had the virus than we currently know. We aren’t testing for antibodies though, so it’s just a guess based on the assumption that if China had cases in November, it likely made it to the US in December, many weeks before the first official case in late January. One thing that concerns me is the low percentage of tests that are coming back positive. Stats I’ve seen suggest ~90% of all tests are negative, which doesn’t test antibodies, but does make it seems like there are many people who still need to get this virus. For the week, the Dow gained 12.8% while the S&P500 added 10.3%. The Dow remains almost 27% below the mid-February highs and the S&P500 is 25% below the highs.      

The government passed a $2 trillion stimulus bill this week. This bill was a necessary evil to keep laid-off workers able to buy food and certain industries from imploding. CNBC reported today numerous flights were traveling with less than 10 passengers. The entire travel, hospitality and restaurant industry is in trouble. Commercial real estate as well. The Cheesecake Factory, which was in a reasonably strong financial position at year end, announced it isn’t paying rent in April on any of its ~300 restaurants. This is happening to numerous businesses and industries across the country as forced shutdowns stretch across the country. While the bailout will help many, it won’t help everyone. The airlines in particular agreed to not furlough any employees through September as a result of receiving the bailout. Many workers are being laid-off though. Last week, over 3.2 million initial jobless claims were filed. To put that into perspective, during the financial crisis, the highest weekly total of initial unemployment claims was 665k. The prior weekly record was 695k set in 1982. Point is, this is significantly higher than anything we’ve ever seen. Read More

Oil climbed this week after its 40% collapse last week, increasing 8.9% to close at $21.60/barrel. There was talk this week oil could drop in the high single digits. Even at the current level, many energy companies could go bankrupt if the price stays here for another few months. The yield on the 10-year Treasury decreased to close at 0.71%, from 0.89% last week. The average rate on a 30-yr fixed rate mortgage declined to 3.50% from 3.65% a week ago.

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3/20/2020 – The Virus Continues

As rough of a roller coaster as the last month has been, this week was actually the worst one yet. This was the third week in the last four that the Dow has declined by more than 10%. The Dow is now more than 35% off the highs reached in early February. Our portfolios weathered this downturn a lot better than the Dow, but it’s still been a painful and challenging time. We are well positioned in that everyone has more than 20% cash in portfolios that can be used to buy stocks at some point in the future. I dabbled a little earlier this week, but plan to remain conservative in deploying capital going forward. There is still a great deal of uncertainty around this virus. It’s difficult to value a company on an earnings basis when no one knows what earnings will be this year and next. The measures we are taking are hurting the economy to save our healthcare system. It’s hard to know whether the medicine will be better/worse than the disease, but we are currently erring on the side of healthcare. While no one knows what the future holds, it feels like things will get worse before they get better. For the week, the Dow declined 17.3% while the S&P 500 decreased 15.0%.

We need massive government involvement to get through this situation. People are already being laid-off and furloughed without pay. The government announced programs yesterday that would allow people financially impacted by the virus to defer mortgage payments for up to 12 months. That is a critical relief for most people. Housing is one of most peoples’ biggest expenses. Something will need to be done on rent, but a ban on evictions seems likely as well. We are shutting down large sectors of the economy. The next step is getting money directly to people. I initially preferred a more targeted approach where the government would backstop payrolls for struggling businesses, but I now think sending every American a monthly check makes the most sense. Congress needs to pass this quickly. People will start missing paychecks next week or the week after. Proposed numbers change from day to day, but if every adult received $1,000-1,200 per month and children received $500/month, people could continue to buy food and pay electric bills over this period. I would hope that people who keep their jobs and don’t ‘need’ the money would donate to friends/family in more need than the the main check can cover. We are truly in uncharted territory and need to keep the basic functions of society working – housing and food being the most important. I would love to see Congress pass this as a single-issue bill. We need money flowing to people as soon as possible as job losses start accelerating.

Bailouts of specific industries is a much more complicated process. We can’t allow this issue to delay getting money in peoples’ hands though. The 2008 bailouts were very difficult politically, although I believe necessary, especially in the financial sector. For whatever reason, over the prior 10 years, we haven’t put plans together for how future bailouts would work. Travel companies find themselves in financial distress after spending billions and billions on stock buybacks over the last 5-10 years. American Airlines spent $12 billion on buybacks since 2014 and now needs a bailout. $12 billion would pay 2 years of labor costs if the airline still had the cash. Boeing spent almost $40 billion in the same period buying back its own stock and is asking the government for $60 billion in bailout funds. In my opinion, there has to be some significant financial penalty for CEOs and senior management that made the decisions that left companies without the financial strength to weather a shock.

Some people would like to see the government let these companies go bankrupt and then reorganize with new equity holders on the back end. From a pure free market perspective, that is the best approach. Owners who made/supported bad decisions would lose money, but the businesses would continue to exist because long-term demand is there for the products/services. One major problem with this approach is the number of companies this could impact and the ownership of these companies by pension funds. Pensions, especially government pensions, are already in bad financial shape. This 35% drop in the the stock market has only exacerbated that problem. If many of these equity investments go to zero, it could create near-term problems for pensions to make monthly payments over the next few years. So the bailout likely needs to save current shareholders. This might end up being a situation like TARP where no one liked it or wanted it and it set bad precedents, but was ultimately the best option out of a list of poor choices.

Oil sold-off sharply again this week, decreasing an eye-popping 40.1% to close at $19.84/barrel. We haven’t seen oil this cheap since the late 90s. The yield on the 10-year Treasury decreased to close at 0.89%, from 1.01% last week. The average rate on a 30-yr fixed rate mortgage moved sharply higher to 3.65% from 3.36% a week ago.

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