On Friday, 3 million new people are on the unemployment roles, which now are at 25 million total.  The ISM production index showed that manufacturing output in its worst shape in the post-WW-II era.

 

 

84% of US small firms are paying less than 50% of rent due in May, and 40% are skipping rent altogether this month (based on a survey from Alignable). Missing rent is going to generate tremendous losses for commercial real estate firms.

 

 

 

According to the ADP private payrolls report, nearly a decade worth of job gains have been wiped out in a month. Below is the ADP summary.

 

 

 

Gold

 

Each time the Fed starts lowering rates Gold jumps and has outperformed the S&P.  It’s usually because the Fed lowers rates to try to stimulate the economy and the US Dollar drops as a result.

 

 

 

 

I think there’s a good chance real rates go even more negative, like they did during the late 1970s.

Back then, as inflation accelerated, real rates turned deeper into negative territory and gold soared by a factor of four. Silver did even better, climbing about seven times.

If the same dynamic were to play out over the next few years, that means $7,000 gold and $110 silver aren’t out of the question. Even if I’m just half-right, you definitely want to own both gold and silver, as well as their equities.

You’ll notice that gold has done well in specific time periods—exactly the kind of periods that trend-following models are designed to recognize and follow. That’s why we use them.

Bottom line: When the Fed starts cutting rates to “save” the economy and the stock market, gold is getting ready to take off.

 

 

Why would real rates go negative?

First, the Federal Reserve is determined to keep nominal interest rates low. To accomplish this, Fed chair Jerome Powell recently announced he’ll buy U.S. debt in whatever amount is necessary.

In the past few weeks, Powell has made good on this promise, boosting the Fed’s holdings of U.S. notes and bonds by more than $1.3 trillion, a staggering 67% increase year over year. With this kind of firepower, rest assured, Treasury yields will remain exceptionally low for as long as the Fed wants.

Second, inflation at the consumer level is poised to rise.

In the late 70s, the catalyst for worsening negative real rates (and soaring gold prices) was a supply chain rocked by suddenly surging oil prices that was brought on by the Iranian revolution.

The food supply chain, the medical supply chain and the energy supply chain have been rocked and the expectation is to move that supply chain back here to domestic production, which WILL produce higher prices.

In short, the Fed is determined to keep nominal interest rates exceptionally low, and non-energy prices are likely to continue rising. Put the two together and it’s just not that hard to imagine real rates turning deeper into negative territory.

If it materializes, this could push gold and silver to new heights.

 

Energy Sector

 

Without government support, the survival of the US shale sector is now in question.

 

 

Crude oil is rebounding, with the June NYMEX contract climbing above $20/bbl. The second chart below shows percent changes over the past month.

 

 

The Fed’s massive injections of liquidity should provide some support for crude oil.

 

 

The Saudi – Russia price war was costly as OPEC’s production surged (just as demand collapsed).

 

 

Refining margins are negative not just in Europe, but now in Asia as well.

 

China

 

Corporate earnings have deteriorated sharply in the first quarter.

 

 

Hong Kong’s GDP registered the largest quarterly decline on record as the recession deepens.

 

 

US imports from China plummeted over the past year.

 

 

The trade deal with China increasingly looks like a pipe dream. The chart shows China’s targeted purchases of US goods.

 

 

 

Earnings Estimates

 

Analysts are having a tough time agreeing on earnings estimates, a sign of extreme uncertainty in business conditions going forward. Based on corporate earnings calls, financing concerns in April were worse than in 2008.

 

 

 

 

Debt

 

A clearer picture is emerging as to what the U.S. debt load will look like for 2020 after the Treasury announced it would borrow a record $3T this quarter to subsidize economic rescue efforts due to COVID-19. That’s on top of first-quarter borrowing of $477B and an anticipated $677B for the third quarter. All the red ink (national debt is near $25T) has some worried about a potential debt crisis and sparked talk about deflation/inflation, while many see the spending as a temporary lifeline, and see the return to growth despite easy money and massive deficits.

 

Stock Market Data

 

Here’s a closer look at the length and magnitude of previous bear market rallies.

 

 

Relief rallies are common after a stock market crash. Is this one due for a pull-back?

Stock Markets are down about 16% from their highs yet are still 30% overvalued.

The latest investment fad is to simply buy the assets central banks are supporting. Charles Gave points out this was also the theory in 1990 Japan and it didn’t end well. He foresees a similar outcome this time.

Key Points:

  • Asset values are (or should be) equal to a future earnings stream, discounted by an appropriate interest rate.
  • In February US stocks were 40% overvalued, fell in March, then bounced to now roughly 30% overvalued.
  • Some now argue the market is no longer about future earnings, but a function of the M2 money supply.
  • This strategy worked well in Japan from 1982 to 1989. It stopped suddenly when profits collapsed.
  • Now, US aggregate corporate profits are quite different from S&P 500 earnings. Gave believes “creative accounting” explains this divergence.
  • Gave expects a downward price adjustment to correct this creative accounting, plus an adjustment to reflect a new, lower earnings level.

Bottom Line: If Charles Gave is right, US stocks will retreat 30% to 35% downside from here, at minimum, just to reach fair value. But note well that “at minimum” part. It could go even lower and, if the Japan parallel holds, be much worse.

  • The latest surveys show that investors are still apathetic about stocks, even after a massive rise. The AAII survey even showed more bears than bulls. Fund flows have continued to be negative, and hedge fund exposure looks tepid, as do Rydex timer positions, futures speculators, and general consumers.
  • Traders panicked in March, sending expectations of near-term volatility to extremely high levels versus longer-term expectations. That has eased and the spread between VIX futures contracts is nearing a 50-day low. But most stocks remain in downtrends, with fewer than a third of S&P 500 stocks above their 200-day moving averages.
  • The Invesco QQQ Trust (QQQ), the main go-to ETF for tech exposure, surpassed $100 billion in market capitalization on Thursday. There have been four other funds that have reached this milestone, all either broad market or S&P 500 funds. We’ll see on Friday that it wasn’t a great sign for those trying to jump on the bandwagon. Over the next 1-2 months, each of the funds showed a negative return.

It’s worth noting here that emotion-driven impulse buys are very different from computer-driven buy signals from trend-following algorithms, even if the same underlying ETF vehicle is used. As you know, we use algorithms, but it’s worth keeping an eye on the emotion-driven waves in the market.

 

 

 

Only 23% of stocks are above their 200-day moving average. That’s an indication of low market breadth, according to State Street.

Big market bounces like we got in April are common in secular bear markets. Look at what happened during the dot-com bubble: After the bubble burst in March 2000, the Nasdaq dropped 35% over the next two months. The index quickly staged a 43% rally and recouped nearly half of the initial loss. It was encouraging for investors, but it turned out to be a classic “bull trap.” When the rally fizzled, the Nasdaq ended up grinding 66% lower before bottoming nine months later. Today, it’s tempting for investors to believe that the bull is back, but they should probably temper their expectations.

 

 

I keep a sharp eye on social mood and market psychology. Right now, people are understandably on edge. The global economy is basically closed for who knows how long, unemployment is at 20%, and the US economy shrank 4.8% in the first quarter. Those are all reasons why the World Uncertainty Index (WUI) is at an all-time high. Today, the index shows that people are twice as nervous as they were after 9/11—which surprised me.

 

The Buffett Indicator

 

Market Cap-to-GDP is a long-term valuation indicator that has become popular in recent years, thanks to Warren Buffett. Back in 2001, he remarked in a Fortune magazine interview that, “It is probably the best single measure of where valuations stand at any given moment.”

 

 

Dividend Strategy

 

With companies cutting their dividends to conserve cash and keep their doors open, income investors need to work extra hard to protect their money stream. This chart from the Financial Times is an eye opener. It shows it will take a projected seven years for S&P 500 dividends to return to their prior high after the cuts expected over the next year. And when a company cuts its dividend, investors express their disappointment by sending the stock price sharply lower. Energy and real estate companies are a major part of the dividend strategy and both sectors will take a huge hit and cut dividends.

 

 

Spanish Flu Comparison With COVID-19

 

The Spanish Flu began in spring 1918 as a particularly deadly strain of the flu and began to spread across the globe. It didn’t originate in Spain… but the name stuck because Spain was particularly hard-hit. The spread of the flu was likely exacerbated by the end of World War I as American troops returned from Europe and then spread out across the U.S. The world was a much “smaller” place back then with less international travel, but this mass global movement of people helped the disease spread. It hit adults aged 15 to 44 particularly hard. The mortality rate was devastating across the globe. According to estimates, it likely infected upward of 500 million people – more than a quarter of the global population. It also killed as many as 50 million (or by some estimates, 100 million), or roughly 3% of the global population. While the coronavirus pandemic isn’t over by any means – we have reportedly seen more than 270,000 deaths out of a global population of 7.8 billion, or 0.003%.

Let’s take a look at the Dow Jones Industrial Average around this period…

The stock market had a rough year in 1917 – mostly due to World War I – but was recovering in early 1918. During this period of economic disruption and incredible volatility with the pandemic, though, the stock market moved much higher.

 

 

Looking back at 1918, the economy took a long period to recover while employment moved back to previous levels and the stock market soared.

 

 

All Content is the Opinion of Brian Decker