We are now going to see a spike in delinquency rates. Here is the Google search frequency for the phrase “can’t pay.”
Households are tapping home equity lines of credit and hoarding Cash at the fastest pace since Y2K 20 years ago.
US business loan balances jumped by the highest percentage on record as companies rushed to tap their credit lines. Layoffs were huge in small business, administrative services, trade/transportation, retail, restaurants and construction. Gains were seen in manufacturing and healthcare.
Is the Bear Market Over?
It appears that stocks are experiencing a “sigh of relief” rally (aka a dead cat bounce) here. As we’ve discussed, these rallies tend to be impressive (hence the headlines for last week’s big gains) and make everybody “feel better” about the crisis at hand. The bottom line is that during the midst of these bounces, folks begin to feel like the worst is over. Check.
Traders got some good news to work with yesterday including the Fed talking about buying stock market ETFs if needed (this ought to put fear in the hearts of short sellers!), Trump extending social distancing recommendations through the end of April (this removes the fear that the administration would do something to make the situation worse), Abbott Lab’s (ABT) 5-min Covid-19 test, and word of JNJ’s vaccine that could start human trials in September (at the latest). To be sure, this is all good stuff.
On the negative side of the ledger, Oil fell to an 18-year low yesterday (crude is desperately trying to stay above the psychologically important $20 level), Macy’s furloughed 130,000 workers (a trend that will continue across the retail/consumer discretionary sectors), and the St. Louis Fed projected unemployment would hit 32% as a result of the “Great Cessation” (it was 24.9% in the Great Depression).
Next up, Goldman Sachs (GS) dropped its projection for Q2 GDP this morning from -24% to -34%. It looks like Wall Street banks are battling it out to see who can come up with the most pessimistic number (Morgan Stanley had been the leader at -30%).
History shows us that the initial bounce from a panic low tends to recover about 30% – 40% of the drop. I will note that the .382 Fibonacci retracement level on the S&P currently stands at 2652 and 22,570 on the DJIA. While not written in stone, such levels “can” provide a decent turning point for a “retest” phase to begin. But not always, of course.
5 Questions
- Employment
Employment is the lifeblood of the economy. Individuals cannot consume goods and services if they do not have a job from which they can derive income. From that consumption comes corporate profits and earnings. Question: Given that employment is just starting to decline, does such support the assumption of a continued bull market?
- Personal Consumption Expenditures (PCE)
Following through from employment, once individuals receive their paycheck, they then consume goods and services in order to live. Question: Does the current weakness in PCE and Fixed Investment support the expectations for a continued bull market from current price levels?
- Junk Bonds & Margin Debt
While global Central Banks have lulled investors into an expanded sense of complacency through years of monetary support, it has led to willful blindness of underlying risk. Question: What happens to asset prices if more bankruptcies and forced deleveraging occurs?
- Corporate Profits/Earnings
As noted above, if the “bull market” is back, then stocks should be pricing in stronger earnings going forward. However, given the potential shakeout in employment, which will lower consumption, stronger earnings, and corporate profits, are not likely in the near term. Question: How long can asset prices remain divorced from falling corporate profits and weaker economic growth?
- Technical Pressure
Given all of the issues discussed above, which must ultimately be reflected in market prices, the technical picture of the market also suggests the recent “bear market” rally will likely fade sooner than later. Question: Does the technical backdrop currently support the resumption of a bull market?
Trying to bottom fish the markets?
Using the 2008 market crash as a guide, this chart shows the hazard of such a move. We should expect to see a series of big market bounces within an unsettled market over the coming months.
Goldman Sachs lists three conditions it wants to see before it has confidence that a market bottom has been reached:
- The viral spread in the US must begin to slow, so the ultimate economic impact of the virus and containment efforts can be understood.
- Evidence that the extraordinary measures taken by the Federal Reserve and Congress to support the US economy are sufficient.
- Investor sentiment and positioning must bottom out, which has not yet happened
In the table above, you can see that from the time investment bank Lehman Brothers filed bankruptcy in the heart of the financial crisis in September 2008 to the market bottom in March 2009, there were plenty of big market rallies.
The S&P 500 gained 9% or more seven times over this period… and each time the rallies happened in about a week or less. Those are big market moves. But remember, these rallies occurred while the index fell 43% in the longer term from September 2008 to March 2009.
The recession that we’re already in – yes, we’re effectively in one already – is going to be sharp and it’s going to get ugly.
The S&P 500 went from a historic decline to a historic bounce to an above average drop. This key benchmark fell 33.9% in 23 days, surged 17.55% in three days and then dropped 5.25% the last four days. In fact, the index has experienced nine swings of five percent or more since February 19th.
Even though the S&P 500 is making a lot of history, it is not making much headway as the index did not even come close to its falling 200-day SMA on the oversold bounce. Clearly, the long-term trend remains down. In case you were wondering, it would take a 51.4% gain to get back to the February highs.
The next chart shows the round trip from October 2007 to August 2012 taking 253 weeks, which is around 59 months and almost 5 years. The S&P 500 fell 56% in 73 weeks and then took another 180 weeks to get it all back. It took more than twice as long to fully recover.
No More Stock Buybacks – with Fed Bailout money
Since the Great Financial Crisis, the primary stock buyer has been the listed companies themselves via their stock repurchase programs. Their net purchases dwarf all others. This is a problem for bulls because the main buyer is suddenly leaving the scene.
The Current Gold and Silver Market
We’ll talk about how the gold market works and why it has been so crazy. First, you must understand two of the most important gold markets in the world; one is the London market, where physical bars of gold are traded. For the most part, this market is where large institutions buy 400-ounce “good delivery” bars of gold. It’s where the so-called “London fix” gold price comes from. The London Bullion Market Association (“LBMA”) and its member banks agree on a price based on buying and selling. The LBMA sets the London fix gold price twice per day – in the morning and in the evening.
The other important market is COMEX, which operates out of New York City.
COMEX is the primary futures and options market for trading metals such as gold. According to its parent company, CME Group (CME), investors use COMEX gold futures to trade the equivalent of nearly 27 million ounces of the metal per day.
COMEX gold futures trade in 100-ounce contracts. But the majority of COMEX gold futures contracts are settled in cash, with no physical gold actually changing hands. Gold must be located in a COMEX warehouse to be eligible for the settlement of the futures contracts.
It’s typical for the most current COMEX futures contract to trade at roughly the same amount as the London fix price for physical gold. So if futures traders need more of the metal from London to settle contracts in New York, it’s easy to buy it at the London fix price, put it on a jet, fly it across the ocean, and take it for storage in a COMEX warehouse.
But last week, the relationship broke down.
At one point, I watched on my computer screen as the COMEX futures price traded for $52 per ounce higher than the London fix price. According to reports, the gap stretched to as much as $70 per ounce on March 24. That’s a 4% premium over the London fix price.
So why did all these things happen? Why did gold crash with the stock market and then recover in a dramatic fashion? Isn’t it supposed to be a “safe haven” that rises in value during a crisis? And why were the London fix and U.S.-based futures prices so different?
In a panic like the one we saw last month, investors sell everything – including gold…
As they sold, prices fell. And if they were using leverage, they received “margin calls.” (A margin call means your broker demands that you put more money into your account or sell some assets when your securities decrease in value.) Some folks didn’t even get margin calls… Their brokers just sold their positions to raise the cash levels in their accounts.
This week, many investment firms had been buying gold with maximum leverage – some as high as 33-to-1. That means they borrowed $33 for every $1 of capital they held.
That might sound familiar to longtime readers… Megabanks like Lehman Brothers had similar levels of leverage during the housing boom that preceded the 2008 financial crisis.
That’s why the gold situation played out the way it did…
The price of gold initially climbed at the first signs of trouble in the stock market. Investors were treating it as a true safe-haven asset, buying it as the storm clouds approached. But then, its price plunged hard as leveraged commodity traders were forced to liquidate their positions to their meet margin calls (or simply had their positions sold out by their brokers).
Fears about spreading the coronavirus led to mass shutdowns around the world – including many gold mines and refineries. Some Swiss refineries closed down completely due to their proximity to northern Italy, one of the hardest-hit regions of the COVID-19 pandemic.
Remember, as I said earlier, the London physical gold market trades in 400-ounce bars… not the COMEX-eligible 100-ounce bars. So normally, for London gold to be used to settle a COMEX contract, it must be sent to a refinery and recast into four 100-ounce bars. (With the recent chaos, COMEX made it possible to settle futures contracts with 400-ounce bars.)
Metals refineries that didn’t completely shut down experienced another problem.
Smaller types of gold coins and bars are more labor intensive and require more workers to make. So it’s nearly impossible to follow “social distancing” to stop the spread of COVID-19.
Even if a refinery is still open today, to keep workers safe, it’s likely that it isn’t making the smaller coins and bars that most investors demand. I recently learned that the Royal Canadian Mint – one of the most famous mints in the world – isn’t even making 100-ounce bars as it keeps operating with a reduced staff. It’s only making 400-ounce bars right now.
Another problem is reduced commercial air traffic…
A lot of gold is shipped as cargo on commercial passenger flights. Fewer passenger flights means less gold can move. And you can’t just load an empty plane with tons of gold. No insurance company would take on the risk of such a large shipment of that type of cargo.
Because of these supply issues, soon after gold crashed all the way down to about $1,475 per ounce in mid-March, it quickly soared back up to more than $1,600 per ounce. The market began pricing in shortages caused by refinery shutdowns and transportation issues.
Demand for physical Gold and Silver is soaring and I’ve heard from more than one company that they’re having some of the best days and weeks of sales in their histories.
However, these record sales aren’t coming without hiccups. An executive of one metals company said it’s not easy to buy physical gold and silver for his big client base right now.
His traders will call one bank that sells the metals one day, and the bank might say, “Sorry, we can’t even give you a quote because we can’t get any metal to sell you today.” Then, they’ll call another bank, which says, “We have metal to sell you… but you’re gonna have to pay a big premium over the quoted price.” And if you call both banks the next day, they’ll tell you the opposite story… as if the limited gold supply were simply playing musical chairs.
If you can even find physical gold or silver to buy, you’ll have to pay quite a bit more than the quoted price per ounce. One colleague told me this week that he saw silver coins on sale at 100% premiums over the spot price (currently about $14.50 per ounce).
We are now Long Gold and Silver!
Interest Rates
The US joins the negative-yield club as Treasury bill yields continue to fall.
The Dangers of Using the Dividend Strategy
“I don’t care about the price, I bought it for the yield.”
First of all, let’s clear up something.
In January of 2018, Exxon Mobil, for example, was slated to pay an out an annual dividend of $3.23, and was priced at roughly $80/share setting the yield at 4.03%. With the 10-year Treasury trading at 2.89%, the higher yield was certainly attractive.
Assuming an individual bought 100 shares at $80 in 2018, “income” of $323 annually would be generated.
Not too shabby.
Fast forward to today with Exxon Mobil trading at roughly $40/share with a current dividend of $3.48/share.
Investment Return (-$4000.00 ) + Dividends of $323 (Yr 1) and $343 (Yr 2) = Net Loss of $3334
That’s not a good investment.
There is another risk, which occurs during “mean reverting” events, that can leave investors stranded.
When things “go wrong,” as they inevitably do, the “dividend” can, and often does, go away.
These companies, and many others, have all recently cut their dividends after a sharp fall in their stock prices. During the 2008 financial crisis, more than 140 companies decreased or eliminated their dividends to shareholders. But it wasn’t just 2008. It also occurred dot.com bust in 2000. In both periods, while investors lost roughly 50% of their capital, dividends were also cut on average of 12%.
While the current market correction fell almost 30% from its recent peak, what we haven’t seen just yet is the majority of dividend cuts still to come.
Naturally, not EVERY company will cut their dividends. But many will, and in quite a few cases, I would expect dividends to be eliminated entirely to protect cash flows and creditors in many cases. Many European companies are stopping dividends.
Do you believe that you avoid market volatility by buying high dividend stocks? Check out this chart that shows, peak to trough, a 40%+ drop this year:
Goldman Sachs said on Monday it expects S&P 500 dividends to fall by 25% in 2020 as certain large dividend-paying industries are particularly vulnerable to the economic shock of the coronavirus outbreak.
The US Economy
The Dallas Fed manufacturing report showed Texas-area factory activity collapsing in March.
New orders:
Here is the New York Fed’s high-frequency national economic activity indicator.
Coronavirus Update
The number of new coronavirus cases in Italy continues to decline.
Coronavirus infections are rising again in Japan and Hong Kong, with social distancing measures being reimplemented.
Market Data
- The S&P 500, along with some sectors and individual stocks, has triggered a Death Cross sell signal. While it did precede some weak short-term returns, it was not a good signal longer-term.
- The three major averages registered their worst month since 2008
- Interesting overlay of present Dow Jones with 1929:
- Last week, buying pressure was overwhelming for 3 sessions. Because it was a short spurt, it wasn’t enough to technically trigger a gold standard of a Zweig Breadth Thrust.
- Ratings agencies have been busy downgrading the debt of S&P 500 companies in recent days. The past month has seen a record number of downgrades, something the agencies are loathe to do, and which they delay as long as possible. The peak has usually come as price declines have run their course.
- Market Valuation. Are we in a good spot yet?
It will be interesting to see how the market behaves on a retest. If a lower low is made, I believe that brings 1,600 to 1,800 into play.
All Content Is The Opinion Of Brian Decker
