America just released last week’s job numbers. Another 3.9 Million Americans lost their jobs taking the total to 30 million in the last month alone…
ECB’s President Christine Lagarde just warned that the Eurozone economy could contract by -12 % in 2020…
Federal Reserve Chairman Jerome Powell voiced concern that the coronavirus crisis could leave permanent scars on the U.S. economy. Powell suggested that the economic battle against the virus would be far from over even if a recovery begins in the third quarter from the deepest recession since the Great Depression. The ongoing public health crisis “poses considerable risks to the economic outlook over the medium term,” Fed policymakers said in a statement on Wednesday after two days of talks.
US corporate earnings are already down -29 % from last year so far, even if better than estimated by analysts who have rushed to revise down their +12 % forecast of the beginning of the year…
COVID-19 is re-appearing in Singapore, China, and Japan where the Government had to close the schools again after having re-opened them…
The airline, automobile, aircraft manufacturers, travel agencies, event-management, sports, entertainment, and hospitality industries are being ravaged with Ford Motor Company
And equities had the longest stretch of 11 up days of more than 1 % in a row since 1974 …
And the Nasdaq is back where it started the year…
Goodbye COVID-19 !
You are already a distant memory…
But is it really? Can it really be with the worst collapse in Consumer Confidence since the surveys have been put in place in 1967
And in the US, the consumer is the MAIN engine of economic growth at 78 % of GDP. Any decline in consumer confidence usually leads to a major collapse in consumption.
And indeed, the figures released today show that Personal spending in the US dropped 7.5% in March, compared to market expectations of a 5% fall. It was the largest decline in personal spending on record.
The rebound in equity markets since March 23rd through has been most impressive, to say the least, and seasoned investors and analysts are at a loss to explain the exuberant rise in the indexes, and even more, in what is becoming their key drivers, the handful of stocks that now compose the largest part of them and capture the imagination of investors: The FAANGS….
There are times in the financial markets where analysts like us scratch their heads and have to question their assumptions as the behavior of the markets are in total disconnect with the realities of the underlying fundamentals…
In such instances, our job is to do and redo our analyses to see if we have missed anything.
The world is going through the worst recession EVER in history – ever because it is the first one of that impacts 196 out of the 197 countries of the planet with the same force –
It is becoming clearer that the recovery as and when it arrives will NOT be V-shaped and that deep scars will be left
And US equity investors are pricing a quick economic recovery, and even more, a phenomenal bounce back in corporate earnings.
AS ALWAYS, WHEN THERE IS A DISCONNECT BETWEEN THE FUNDAMENTALS AND MARKET EXPECTATIONS, SOMETHING ULTIMATELY HAS TO GIVE IN…
IN THIS CASE, IT IS DOUBTFUL THAT THE FUNDAMENTALS WILL GIVE IN…
But let’s analyze what is driving the markets higher
There are interesting features in the current massive rebound in US equities :
- The rebound has not followed the traditional pattern of a lasting bottom.When a bottom happens, it normally takes a re-test of the lows to confirm that the selling has been exhausted and that the balance of power between buyers and sellers is changing.A re-test of the lows can take several configurations: either a higher low is made, or a double bottom is made, or even, a marginal new low is attempted and quickly reversed to close above the previous low.
In this instance, none of that has happened and the sharp move up has been in a straight line with almost no significant pull-back along the way…
THE WORRYING CONCLUSION OF THAT PATTERN IS THAT THIS REBOUND LOOKS MORE AND MORE LIKE A BEAR MARKET RALLY THAT WILL GIVE WAY TO THE SECOND LEG OF THE BEAR MARKET, A MUCH MORE DEVASTATING ONE THAN THE FIRST ONE
- The rebound has been powerful but on declining volumes. What this means is that although the initial thrust was impressive at first, there is little follow up buying from long term investors and that the holding power of the current buyers is probably weak.
- Institutional sentiment remains stubbornly low considering the magnitude of the rebound. In purely technical terms, as the rebound has taken the indexes back above the threshold of bear markets ( -20 % ), long term professional investors should interpret it as a sign that this was just a correction and consequently should re-allocate money to the market. Their ongoing pessimism means that they worry about the fundamentals more than the indexes show.
- NEVER IN HISTORY, have the decline and the rebound been SO SHARP and SO FAST. As the following chart shows, the SP500 lost – 35.3 % in 4 weeks and rebounded by +34 % in four weeks as well… Far from being a positive sign, it is a sign of extreme uncertainty !!! AND IT WORRIES US CONSIDERABLY BECAUSE IF THIS REBOUND PROVES TO BE A BEAR MARKET RALLY, IT MEANS THAT THE ENTIRE BEAR MARKET MAY BE UNFOLDING MUCH FASTER AND MUCH SHARPER THAN ANYBODY EXPECTS…
Who is buying this rally? and why?
As we predicted in our THE END OF COVID article, the first leg of the rebound had to be fed by expectations of a taming of the Virus which peaked on April 17th as expected and is delving almost everywhere, apart from Asia.
Investors are feeling more comfortable that the pandemic will be brought under control and the gradual return to normalcy in the coming weeks with the lifting of confinement measures.
Positive news about vaccines and treatment from GILEAD and other biotech companies have also fed optimism. However, the WHO and the scientific community are warning about a possible resurgence of the Virus in the fall as well as with patients that were cured of the first bout of infection.
Finally, the “whatever it takes” approach of Central banks and Governments are interpreted as a ” Market PUT” protecting equity investors, as is the case in “normal” conditions.
However, what is striking is that very few analysts are focusing on the long term effects of this massive money printing exercise and unprecedented accumulation of public debt, as very few focus on econometric models showing the final impact of 30 million job losses in an economy that employs 157 million people.
This represents 19 % of the American working population and the only equivalent rise in the unemployment rate was in 1929, and it took longer to unfold then …
If institutional investors have not been extremely active in the large caps space, according to the surveys, they have definitely snapped smaller companies on the cheap.
After a period of underperformance, the Russell 2000 has finally outperformed the main indexes and has now retraced 50 % of its sharp March decline. This is an interesting element as economics agree to conclude that Small caps will probably be the most affected.
However, institutions remain prudent and are keeping cash levels extremely high.
Share Buybacks and insiders
Share Buybacks were one of the main drivers of the rally in 2018 and 2019 as the combination of the one-off liquidity injection of Donald Trump’s tax cuts and extremely low nominal interest rates drove highly leveraged corporations to buy back their shares massively over the period, driving valuations abnormally high.
This has all but disappeared as corporations are rushing to draw on their credit lines to keep as much cash as possible and no board of directors today is willing to use cash to buy shares when CEOs have completely abandoned the idea of making business projections for the future.
In some limited cases in Biotech or family-controlled businesses, owners are allocating some cash to buy their shares on the cheap but this is a marginal phenomenon and it has always been a hallmark of bear markets.
Individual investors were the first to sell indiscriminately in March and have been piling back in their favorite names in this rebound, namely the FAANGSs.
Apple, Microsoft, Netflix, and Amazon have been driving this leg of the rally with rises of anything form 40 to 60 % as investors and analysts to tout the life styles and work styles shifts towards work from home and distanciation.
And indeed these shifts are visible in the Q1 numbers of Microsoft, Netflix, and Amazon, and Facebook today reported more resilience of the digital advertising space.
However, the initial impact is logical as corporations all had to switch from brick and mortar to online sales, but it is truly doubtful that these growth rates will be sustainable.
Moreover, the full impact of COVID will really be seen in the second-quarter numbers and the decline in consumption will be truly visible in the months to come. Digital advertising was extremely strong in the first six weeks of the year, a switch from brick and mortar a natural thing in the past few weeks, but the global macro impact on advertising in general and digital advertising will become really palpable in the current quarter.
As our readers know, our END OF TECH theme was developed way before COVID appeared and was based on unsustainable valuations and parabolic price moves that are unsustainable. Our analyses are even more valid today as all these companies can only be affected by the global macro recessionary scenario.
Besides, Individual investors are weak holders as could be seen in March, and it the markets Strat turning down, they will be selling as fats as they have been buying hope.
Finally, with 30 million unemployed, households will have to draw on their savings, and the first casualty will be their 401-K pension plans.
Algorithms are young and have strictly no ability to factor in external shocks of that magnitude. They are trading on patterns observed in. formal market conditions and they have been extremely instrumental in giving the impulse at turning points and creating momentum in the down and up phases.
The danger with algorithms is that when the markets turn, they will do the same on the way down.
Hedge funds and technical analysts
Hedge funds and technical analysts are, for many, patterns and trend-followers that, again, base their analysis on past trading patterns and psychological balances and imbalances at any point in time.
And this is probably the most interesting part of the analysis.
For now, technicians have moved form bearish to bullish and the current patterns give them a bullish framework with some of the most prominent considering that the March 23rd bottom is a long term bottom and that equity markets are starting a new cyclical bull market for the next 4 years.
However, technical analysts are also famous for re-interpreting their technical projection when unforeseen moves unfold, and the most interesting observation is that in the past 2 years, their frameworks have been unable to predict accurately the moves, or to be more precise, not the timing of the turning points but the MAGNITUDE OF THE MOVES.
In the past two years, they have missed :
. The peak in equity markets in January 2018.
. The extremely sharp correction of December 2018
. The FED induced bull leg of October 2019-Feb 2020
. The depth of the March Correction
. The speed and magnitude of the current rebound.
If this bull phase peaks soon as we expect, and a structural LOWER HIGH is formed, their analytical framework will change to the unfolding of the second leg of the structural bear market that was bound to happen anyway considering the overleverage of the US economy in particular.
Technical analysis and trend followers give no importance to earnings and valuations and rely purely on investors’ psychology.
Our analytical framework is a holistic process that starts from the structural organization of societies and economies, steps down to the global macroeconomic trends, then to the geographical macro trends of the various economies, then to the industrial sectors, credit risks, and individual corporations.
And finally, we use technical analysis and flow-of-funds to identify turning points.
And our Conclusions at this stage are :
1. The world is going through the deepest and uniquely global recession of the past century.
Never in world history have so many countries been affected at the same time, so many people losing their jobs at the same time, so much money being printed by central banks, so many assets being bought by central banks and so much public debt being added at ONCE.
Anyone dismissing these fundamental macro-trends as a passing phenomenon is bound to have a very sever wake-up call in the months to come.
2. COVID-19 is exposing the relative frailty of the structural and social organizations of the various societies and economies around the world and some countries will emerge better than others.
As we have argued many times in the past, and in particular in our theme THE END OF AMERICA whether we like it or not, the Chinese public governance and economic management are what explains their phenomenal success of the past 40 years and it is again their public governance and semi-managed economy that will help them pull out faster than the rest of the world of this crisis.
The same applies to the largest Asian economies such as Japan, Taiwan, Korea, Singapore, and Hong Kong where a MORE COHESIVE society and a culture of life long employment will buffer the effects of the downturn on employment and consumption.
Europe’s high levels of social protection and stringent labor laws will have the same effect to a lesser extent, even if higher public debts and deficits will act as a drag for much longer.
The main casualties of COVID-19 will be the more capitalist democracies of the West and in the first place the USA where the combination of extreme leverage and absence of social protection will combine to trigger high unemployment, a collapse in consumption, significant numbers of bankruptcies, and social unrest.
The UK, Australia, Canada are also bound to suffer although to a lesser extent.
Finally, many emerging market economies will see significant declines as well as a leg health crisis even if not reported.
From a more philosophical standpoint, COVID_19 is going to bring people and economies back to the realization that the countries, industries, corporations, and individuals that will survive the crisis will be the ones that have kept large cash buffers and savings while those who have been living on debt and low savings will suffer the most.
One of the main lasting consequences of COVID-19 will be a substantial increase in savings rations and a lasting reduction in unnecessary consumption.
The shift to working from home and social distancing will be more lasting than expected and have significant consequences on transportation, travel, luxury consumption, hospitality, tourism, and ultimately fuel consumption, hence the collapse in oil prices and demand.
3. The World is going through the WORST EARNINGS RECESSION of the post WW2 era and country to analysts’ expectations that are based on nothing today, it will take a few years to climb back to the peak earnings levels of 2019.
As a consequence, equity valuations have shot up to levels that make them totally unsustainable, regardless of interest rate levels. Moreover, in not too long, interest rates will start rising again following inflation and distrust of fiat money as Governments are competing to finance their budget deficits and central banks have no ammunition left to buy assets beyond the current levels of 30 % of the world GDP.
The sudden increase in public debt of 10 % of the world GDP will force Governments to raise taxes at the worst possible time, exacting another negative impact on corporate earnings and cash flows, in a reverse phenomenon.
Anyone believing that the earnings recession is over or even reaching a through will be disappointed as will any analysts believing that valuations can stay where we are.
In other words,
Contrary to our initial assessment in March, because of its speed and magnitude, the current rally looks more and more like a compressed bear market rally that will give way to an equally sharp and much more devastating second bear leg in the US stock market.
Only China, Japan, and some emerging stock markets may have bottomed and will recover earlier.