No RMD’s for 2020!

Because of the poor performance of stock markets to begin the year, and the hardships imposed by the COVID-19 (coronavirus) and accompanying government restrictions, Congress recently waived the Required Minimum Distribution (RMD) requirement for 2020 in its recent stimulus bill.

Penalty Free Distributions

Another aspect of retirement accounts is the fact that early withdrawals, i.e. those that take place before investors turn 59 ½, incur a 10% penalty on top of taxes owed. That’s to discourage investors from treating retirement accounts like ATMs.

The CARES Act stimulus bill allows investors affected by the coronavirus to take an early withdrawal of up to $100,000 from their IRA without having to pay the early withdrawal penalty. Investors will still have to pay taxes on those distributions, but they have up to three years to pay those taxes, and they can also put that money back into their IRAs within three years and avoid paying taxes on the distribution

Higher 401(k) Borrowing Limits

Investors can now borrow up to $100,000 from a 401(k) account, double the amount they were able to borrow previously. As with IRAs, the 10% early withdrawal penalty has been waived. And again, this is supposed to be for people affected by coronavirus, so make sure to consult with both your tax adviser and your 401(k) plan administrator before borrowing from your 401(k) account.

When is the cutoff deadline to make IRA contributions for 2019? This too, just like the tax filing date has been extended until July 15th, 2020.

 

Debt Crisis Awaits in the Emerging Markets

 

Many of the world’s poor and developing countries could begin defaulting on their bonds in the coming weeks as the coronavirus outbreak has led to massive outflows from emerging market assets and real-world dollars being yanked from their coffers.

The wave of defaults is unlikely to be contained to EM assets and could exacerbate the global credit crisis forming in the world’s debt markets.

The emerging world is being battered on all sides by a slowdown in manufacturing, cratering oil prices and the depression of aggregate demand as a result of the COVID-19 outbreak.

The suffering expected in developed economies like the U.S. and Eurozone will be compounded significantly in emerging economies, like those in Asia, Latin America and Africa, which are expected to drive the world’s growth in the coming years.

There are at least 20 EM countries that have bond yields already trading at distressed levels of more than 10 percentage points above comparable U.S. Treasuries, with Venezuela, Argentina and Lebanon having already entered defaults.

 

Where is the Low in This Market?

 

Since 1929, there have been 13 large waterfall declines. In nine cases, the Dow Jones Industrial Average broke the lows. In the three of the four cases the low was not broken, but the lows were retested. The lone exception is December 2018. There was no immediate retest. Suffice it to say that low was finally broken last month. So call it 13 for 13. There were also twenty -15% or more waterfall declines since 1929. Twenty of the twenty have had their lows retested.

 

 

According to Ned Davis Research (NDR), the stock market peaked on 2/19/20. At the low (which occurred on 3/23/20), the Dow had declined -37.1% in just 40 calendar days. For the record, NDR defines a bear market as follows: “A cyclical bear market requires a 30% drop in the DJIA after 50 calendar days or a 13% decline after 145 calendar days. Reversals of 30% in the Value Line Geometric Index also qualify.” In this case, it was the dive in the Value Line Index that qualified the current dance to the downside as a bear market.

NDR’s computers tell us that since September 1900, there have been 36 cyclical bear markets. The average decline for the DJIA has been -35.6% over a period of 399 calendar days. So, the decline of -37.1% is in the ballpark but the duration of 40 calendar days is super short relative to the historical mean.

We can then look at bear markets that occur during secular bull and bear cycles. Here’s NDR’s definition of a secular cycle: “A secular bull market is a period in which stock prices rise at an above-average rate for an extended period and suffer only relatively short intervening declines. A secular bear market is an extended period of flat or declining stock prices. Secular bull or bear markets typically consist of multiple cyclical bull and bear markets.”

During cyclical bears that occur within secular bull cycles, the average decline has been -21.8%. Whereas the average bear that occurs during secular bear cycles is -36.3%. Ouch.

Next, since lots of folks believe the U.S. entered a recession in March, we can also look at what happens during bear markets that are accompanied by a recession. NDR’s Ed Clissold reports that the average decline for bear markets that are accompanied by a recession is more along the lines of the declines during secular bear cycles – or about -36%.

So again, the Dow’s most recent drop of -37.1% to the 3/23 low would seem to be a fairly average “discounting” of the bad economic news that is to come. But lest we forget, the damage associated with the last two recessions was far worse.

And in a Barron’s report, David Rosenberg points out that since WWII, bear markets have “taken back” an average of 71% of the prior bull market’s gains (and a median of 54%). According to Mr. Rosenberg, if history were to repeat here, the S&P 500 could decline to either 1455 or 1798 (or a drop of between 28% and 45% from Friday’s close), depending on whether your statistical preference falls to the means or medians. That’s not good news.

Last Monday was a good day for stocks, as the S&P 500 rose by 7%. But large gains during bear markets are not uncommon.

 

 

 

What we are looking for in a market bottom

 

Back in 2008, the Dow’s RSI (relative strength index) dipped to a low of 19 before it eventually made a “higher low” coinciding with the ultimate U.S. stock market bottom in early 2009.

Off this extreme low, the market shot up 24% in about two weeks, and then proceeded to decline another 33% before the final bottom in March of 2009.

Notice what happened with the RSI at the bottom – it made a higher low than price (dashed blue line). That was the major signal that a rally was ready to unfold. That was what marked the bottom.

The “divergence” shown with blue dashed lines in the previous chart, one going down and the other going up, is considered an indicator of a market turning point.

 

 

Here’s the same chart in 2020, as of Friday’s close…

Last month, the Dow’s RSI hit the exact same level (19) as it did in 2008. And the market rallied 24% into the high last week… the exact same price action at the exact same indicator level.

 

 

Do we see another 33% decline from here?

During the last bear market from 2007 to 2009, it took 352 trading days for the Dow to go from the high to the low. And in that span, it experienced a 54.4% decline.

Not long ago, the market had dropped 38.4% in 27 days from its February highs.

There are only two other precedents when this type of move happened… 1987 and 1929.

In 1987, the market dropped 41% from the high to the low in 38 trading days.

In 1929, the market dropped 48% from the high to the low in 49 trading days.

 

 

So either 2020 is the fastest bear market (27 days) and we bottom soon (like 1987), or we are on the cusp of a 1929-like market, which means more downside ahead and the bear market will last for one or two more years.

 

 

We are due for one more (at least) big decline below the March 23 [2020] low.

This also aligns with the possible 33% decline from the first two charts above. The rally from the secondary high within the blue circle above in 1929 fell another 27% before bottoming out.

So you can see that both the 1929 and 2008/2009 time frames suggest another big drop is coming.

Assuming we get a new low, we need to look at the weekly RSI – it should make a higher low with a new low in price, just like in 2009. And that will mark the bottom.

An excellent diagram laying out the 4-phases of the full-market cycle.

 

 

Where are we now?

Let’s take a look at the past two full-market cycles, using Wyckoff’s methodology, as compared to the current post-financial-crisis half-cycle. While actual market cycles will not exactly replicate the chart above, you can clearly see Wyckoff’s theory in action.

Here are some examples:

 

 

 

 

So, here we are, a decade into the current economic recovery and a market that has risen steadily on the back of excessively accommodative monetary policy and massive liquidity injections by Central Banks globally.

Once again, due to the length of the “mark up” phase, most investors today have once again forgotten the “ghosts of bear markets past.”

Despite a year-long distribution in the market, the same messages seen at previous market peaks were steadily hitting the headlines: “there is no recession in sight,” “the bull market is cheap” and “this time is different because of Central Banking.”

This is the story told by the S&P 500 inflation-adjusted total return index. The chart shows all of the measurement lines for all the previous bull and bear markets, along with the number of years required to get back to even.

 

 

 

On the far right, we can see that the S&P 500 has definitively broken below its green Long-Term Support Line that was first established back in 2008.

The chart below shows that S&P 500 prices initially bounced sharply higher (17.2% gain) towards the 38.2% Fibonacci Retracement level, then fell rapidly by -6% before bouncing again on Monday by 7% to close the day just below the 38.2% Fibonacci level. On Tuesday, bulls attempted to push prices higher above the 38.2% level but ended the day being driven back to where they started just below that critical level.

 

 

The probability is growing that – informed by additional bearish indicators – in the coming days and weeks; we will see prices return downward to test the March 23 low at 2237.68. From there, we’ll need to make another assessment to determine whether a recovery is possible or if we are just at the beginning of a long bear market that could see the S&P 500 declined to the 1500-1600 level (-42% lower).  In 2020, the surge in unemployment, combined with a shuttering of business, will have a substantially deeper impact on gross consumption in the economy than in 2008. Over the next few months, stocks will begin to price in the severity of the economic damage, a substantial decline in earnings, and the realization that hopes for a “V-Shaped” recovery are not likely.

Ray Dalio predicts a coronavirus depression. Dalio, who runs the world’s largest hedge fund, Bridgewater Associates, sees the coming economic downturn as resembling the effects of the Great Depression, which lasted from 1929 to 1933 and is regarded as the worst economic crisis in American history. The Great Depression saw U.S. unemployment hit a peak of nearly 25%, while gross domestic product (GDP) declined by nearly 30%.

 

 

Inflation or Deflation?

 

Close to 17 million people have filed for unemployment in the last 3 weeks. It would be significantly higher if overwhelmed websites in many states were able to actually take all the claims.

The Federal Reserve has rightly intervened in order to prevent the absolute certainty of a deflationary depression.

Milton Friedman posits that “… inflation is always and everywhere a monetary phenomenon.”

Here is Lacy Hunt’s latest velocity chart. You have to go back to 1949 to find a time when it was lower than today, and it was actually rising rapidly off the postwar lows. This was before the coronavirus shutdowns. The velocity of money is now going to drop even further. Deflation is not your friend.  We have a deflation issue, NOT inflation.

 

 

By putting the economy in lockdown, taking away the income of multiple tens of millions, much of the CARES act simply replaces lost wages. That is not stimulus. That money doesn’t generate additional spending. The SBA loans are not stimulus in the traditional sense. The money is hopefully going to bring many businesses back from a dead stop. That will be good, but it’s not stimulus.

This last $2.2 trillion is not money printing. They are simply buying already existing bonds, not unlike QE in the past when the Federal Reserve bought US government bonds. This is not like Venezuela, Argentina, or Zimbabwe. Not even close.

Nonetheless, $8 trillion and counting of government expenditures, funded by the Federal Reserve, is nothing to sneeze at. It will have an effect on the money supply. So is Milton Friedman right? Is inflation on its way back?

 

Debt

 

We Have Created the Biggest Excesses in Generations

Swiss money manager Felix Zulauf says the world won’t be the same after this coronavirus crisis ends, in part because unwise debts now far exceed 2007 levels and are increasing the downward pressure. But he’s not entirely bearish and describes some opportunities.

Key Points:

  • Skyrocketing risk premia in the high yield segment are moving through the system and will jeopardize refinancing even for healthy companies.
  • Central banks need to prevent system meltdown, but it isn’t clear they can remove their liquidity injections before inflation takes hold.
  • Loose monetary policy during the expansion is now proving disastrous.
  • As USD rises, dollar-denominated debt in emerging markets, especially China, will be a huge problem.
  • Zulauf doubts European banks have enough capital to absorb the bad debts they will face.
  • In equities, Zulauf thinks the greatest damage is behind us but large fluctuations will continue.
  • The march toward more intervention is not a climate for structurally increasing prosperity.
  • Increasing devaluation of paper currencies will be positive for gold.

Bottom Line: The deficit this year will likely be $4 trillion-plus. Note that we are already at $24 trillion total federal government debt in the US. Add another $3.3 trillion for state and local debt. Our debt projections only a year ago showed the US federal government debt going to $30 trillion by the middle of this decade. It turns out we will be there by 2022. The almost $40 trillion I projected by 2030? That will now happen in the middle of the decade and we will be nearing $50 trillion by the end of the decade.

Here is the rollout:

March 6th – $8.3 billion “emergency spending” package.

March 12th – Federal Reserve supplies $1.5 trillion in liquidity.

March 13th – President Trump pledges to reprieve student loan interest payments

March 13th – President Trump declares a “National Emergency” freeing up $50 billion in funds.

March 15th – Federal Reserve cuts rates to zero and launches $700 billion in “Q.E.”

March 17th – Fed launches the Primary Dealer Credit Facility to buy corporate bonds.

March 18th – Fed creates the Money Market Mutual Fund Liquidity Facility

March 18th – President Trump signs “coronavirus” relief plan to expand paid leave ($100 billion)

March 20th – President Trump invokes the Defense Production Act.

March 23rd – Fed pledges “Unlimited QE” of Treasury, Mortgage, and Corporate Bonds.

March 23rd – Fed launches two Corporate Credit Facilities:

  • A Primary Market Facility(Issuance of new 4-year bonds for businesses.)
  • A Secondary Market Facility(Purchase of corporate bonds and corporate bond ETF’s)

March 23rd – Fed launches the Term Asset-Backed Security Loan Facility (Small Business Loans)

April 9th – Fed launches several new programs:

  • The Paycheck Protection Program Loan Facility(Purchase of $350 billion in SBA Loans)
  • A Main Street Business Lending Program($600 billion in additional Small Business Loans)
  • The Municipal Liquidity Facility (Purchase of $500 billion in Municipal Bonds.)
  • Expands funding for PMCCF, SMCCF and TALF up to $850 billion.

An alphabet soup of new asset-buying programs will essentially nationalize large swaths of the financial markets, and the consequences could be profound.

In fiscal year 2019, the federal Government spent $4.4 trillion, amounting to 21 percent of the nation’s gross domestic product (GDP). Of that $4.4 trillion, only $3.5 trillion was financed by federal revenues. The remaining amount ($984 billion) was financed by borrowing.  Ultimately, continuing to “kick the can” not only increases the risk of the next crisis, but slows the economic recovery, and further impeded future economic growth.  In other words, while investors are currently banking on the Fed’s numerous monetary injections to fuel asset prices higher, there is a real possibility the Fed is simply “filling in a hole” that is growing faster than they can fill it. (The Fed is injecting $6 Trillion via the balance sheet expansion versus a potential $10 Trillion shortfall.)

 

 

Coronavirus Update

 

Daily new cases in the US:

 

 

Fatalities

 

 

The number of new infections is peaking.

 

 

The recent growth in new COVID-19 cases has been slower than experts predicted a week earlier.

 

 

Below is the total number of cases by country.

 

Credit

 

Desperate for liquidity, some firms are paying up to obtain financing.

 

 

 

WeWork bonds are yielding 35%, which means they are expected to default.

 

Market Data

 

  • Few stocks within the S&P 500 have managed to climb above their 200-day moving averages. While that has typically meant the worst of the selling is over, it can also be early in the “puke” phase of a decline. If we optimize the parameters, we see that a good compromise is waiting until there is a modest sign of recovery.
  • The financial sector hasn’t done much to confirm the idea that stocks are near a bottom. On a relative basis, they continue to reach lower lows. But a look at past bottoms shows that this is not unusual behavior, as the group rarely leads out of major declines.

 

 

  • The S&P 500 realized volatility reached the highest level since the crash of 1929.

 

 

  • The CNN Fear & Greed model has moved into neutral territory. Dumb Money Confidence has finally pulled out of a stretch of deep pessimism. During bull markets, this is usually a sign the worst is behind us. During bear markets, this is where markets usually run into trouble.

 

 

All content is the opinion of Brian Decker