3/24/2020 Where we Stand
Don’t Fight the Fed. This is a trader’s moniker. It has so far served those that adhere to it very well. The Fed has committed unlimited amount of US dollars (which they have the legal privilege to create out of thin air at basically no cost) to hold the world economy together. With favorable news regarding the Corona Virus and a deal on Fiscal Stimulus from Congress pending, the rally today is not surprising.
It was strong. 11/1 advance decline. This is not untypical for a bear market rally. We never got the signal we hoped to get from TRIN. So, we remain skeptical that an interim bottom is in. Still, we are way below the highs and we got extremely oversold, so perhaps a retracement of the first leg down has begun. Thus, we think it would not be imprudent to allocate 1/3rd of your cash reserves and 1/3rd of any hedges to stocks and bonds at this point or to you appropriate target allocation and/or appropriate Cabana fund.
What has us really bum-fuzzeled is the early and extraordinary measures employed at this stage of a nascent downturn to combat Covid19 and the fear and financial damage created by it. Extreme financial policy tools have been employed very early in this particular bear market. Usually they don’t appear until after the largest wave down of a bear market has occurred. Thus, we don’t know if we are near the beginning of a new micro-bull market that will be created anew from these measures (assuming the Coronovirus risk is addressed in a manner that permits the population to get back to work) or whether after the rally to come, we’ll turn down without making a new top and proceed to have a full bear market. Who knows!?
The big rally we experienced today underscores why we never suggest completely abandoning a long-term market neutral positioning. Missing out on big days can be expensive and painful to be sitting in 100% cash. Likewise, we’d like to reiterate that it makes good sense to work your way out of inverse stock funds and employ cash on big down days. What surprised us about this leg down is that it blew right past the first support level which had us focused on the next one at the 2015-2016 levels. Who knows, we may still get there. But, after today’s launch, who knows?! Another fact that is making matters difficult to gauge is NYSE volume is unreliable since the physical floor of it is closed due to Covid19. So our crystal ball has gotten extremely murky. NASDAQ volume was slightly negative most of the day. With NYSE traders perhaps trading there from home, which would suggest that NASDAQ volume should track higher, we had no clear volume signal. TRIN was not particularly illuminating as well.
Honestly, we are miffed and are short on predictive powers at this point. Without question in our minds, a recession has begun. The economy has essentially come to a hault at a time of record debt and, market drop notwithstanding (with the exception of energy stocks) stock prices are not cheap yet (other than in emerging markets). Moreover, with the record issuance of corporate bond debt to fund corporate buy-backs, many-many Company’s are insolvent if the current level of economic activity were to continue for any meaningful amount of time. Unemployment will have spiked. If that trend continues, financial policy tools employed notwithstanding, we could go down hard. Confidence will likely be shaken, money may be tight, and the recession could deepen. What do you think? Suppose a Coronovirus treatments is successful and available and people go back to work, will you spend like you did before the incident or will you be more cautious? Are you gonna spend or save your government stimulus check? We don’t know the answers to those questions and once they become clear, all will already be reflected in price. The answer to those questions may shed some light as to which way we are heading. But for Fed Purchasing and the extreme fiscal measures Congress is now debating, we’d venture to guess that a huge amount of corporate debt is unserviceable. That sets up bankruptcies and liquidations. We are now in one of the most uncertain and high risk-as to ultimate direction- times that we’ve ever seen.
We think there are several possible options.
5%. The bear market continues from here and we go into a great depression. This could happen in our view if the world cannot get back to work and unserviceable debt destroys the economy notwithstanding the efforts to stop this.
25% chance. We make a new low soon not more than 15% to 25% below where we are right now, retrace 38%. 50% or 62% of the fall from the top and the bear market then continues.
50% chance. We made a low already, will retrace 38%, 50%, or 62% of the fall from the top and the bear market continues.
10%. The bear market is already over and we make new highs from here.
10%. We make a new low somewhere below today’s close but not deeper than the 2015 lows, but then the bear market ends and we go on to make new highs.
But for the early application of extraordinary financial policy tools, unlimited QE and a large fiscal stimulus to come, we’d mark the last two items off of our list. These are unprecedented times. We are sorry we can’t be of greater help. There is simply no other period we can look to which is sufficiently similar to our own for confidence.
Bonds: We like here investment grade bonds. It they go lower, given the Fed’s commitment, we like them even more. But for the Fed, we wouldn’t buy them for (since they imploded the last two weeks) anything, much less stocks. That fact makes it hard to like stocks, but again, the policy measures could drive them higher, valuations and weak balance sheet notwithstanding. We expect support on short term bonds from the Fed as well as well as intermediate government bonds. We doubt they’ll push hard on the long dated bond and see the inverse there as being a good bet for the intermediate future.
We think gold will fizzle hard sometime this week. We think a short term peak is in, that the retracement rally of the first leg down will end tomorrow or this week and gold will eventually break the 2015 lows at which point, we’ll really like it. On the other hand, if the economy does not improve and bonds and stocks turn down, gold could go crazy. We doubt this will happen, but it could. If it does, we’d be very concerned. That’s why we like some in a portfolio all the time, just more when its cheap and oversold and less when its expensive and over-loved.
We like the valuations much more in emerging market stocks but we don’t know what kind of shape their balance sheets are in and whether they could handle more economic weakness.
At this point, a little less cash, less hedges, but primary reliance on your appropriate target allocation fund and appropriate Cabana fund for the bulk of your holdings makes the most sense. We are definitely not in the situation where we would say to go all in on anything. Sorry, there is just that much risk and prices really aren’t at bear market low levels yet.
Good luck out there, it is absolutely crazy.