If you’re not sure what this title means, join the crowd. But it appeared in a news feed about money that I follow. I decided to read it anyway.
It essentially confirms my gut feeling that the recent rally in the stock market is/was masking the reasons for further capitulation to reality as the crisis plays out.
If you have money ready to put back into the markets, this is an important read for you. He has a lot of good chart images to support his arguments that I’ve not replicated here. I’ve given you a link so you can see them. Stay safe!
by Ariel Santos-Alborna \ 30 MAR 2020 \ https://tinyurl.com/tk7dsef
- This is an unprecedented supply and demand shock to the global economy.
- It’s unlikely that this is the shortest bear market in history.
- Vicious bear market rallies are quite common.
- Corporations will not have the cash flows to conduct stock buybacks.
- The bond market is saying this rally will not last.
The S&P 500 fell 35% from its late February highs amidst the worsening of the coronavirus epidemic. It regained nearly 16% of its tumble in a week on news of a massive stimulus plan and oversold conditions. The markets went through their initial de-risking and deleveraging phases in the initial drop. As the financial world deleverages and receives massive stimulus, the markets experienced a relief rally. The next phase of the coronavirus epidemic will play out in the real economy through continued supply and demand shocks.
For better or for worse, the liquidity issue will be alleviated through “QE infinity,” though with implications to the soundness of the U.S. dollar and legitimacy of central banking. However, the issues of medical system failure, corporate earnings, consumer spending, and manufacturing will not be resolved with a printing press. Below are five reasons why I believe the bottom is not yet in for the coronavirus bear market
1. It’s worse than you think
The restaurant industry alone employs 15.1 million Americans. For perspective, nearly one in every ten Americans works in restaurants. With restaurants and other service sectors shut down, 3.3 million Americans filed for unemployment benefits. As the chart below shows, that is nearly five times the number of the Global Financial Crisis, and the crisis has not yet hit critical mass for the United States.
This will cause an unprecedented demand shock for the global economy, as the U.S. consumer is truly a global consumer. A $1,200 stimulus check will not resolve this issue for two reasons. Firstly, with this many Americans filing for unemployment, these checks will go towards rent, groceries, and the like – simply replacing the reduced demand going towards living essentials. Secondly, as consumer confidence is the inverse of unemployment, most consumers will not want to spend unnecessarily under an environment of such uncertainty.
The supply shock is also worse than most Americans think. Global PMIs have fallen off a cliff as economies grind to a halt. If GDPs generally track the PMI, it follows that upcoming GDP numbers will be horrendous. My first point is this: while investors argue about whether the bottom in the stock market is in, real world employees are being laid off at record numbers and employers are filing for bankruptcies. It is unlikely that markets will rally to new highs as the global economy halts activity.
2. Length of bear markets
History indicates that bear markets are prolonged events. In the dot-com crash of 2000, the S&P fell 49% in two years. In the Great Financial Crisis, the market also took two years to fall 57%. Stock market bulls are thus making the argument that the bottom is in after a 35% drop that took 31 days. Bulls are making the argument that this is the shortest bear market in history.
There are certain things to consider. For example, if Fed policy has extended the length of bull markets, it can certainly shorten the length of bear markets. We have also never witnessed the monetary bazookas of QE infinity, “stimulus” checks (not really stimulus if replacing lost demand), and a slew of corporate bailouts. Taking this into consideration, I added to my S&P long positions after the 30% drop because I was already very underweight U.S. equities. However, I still have cash on hand in the likely event of further downside. I do not attempt to perfectly time every top and bottom but analyze the probabilities and act accordingly. In my opinion, 31 days is not enough for a bottom given the magnitude of the situation.
3. Bear market rallies daily point gains
The chart below shows the top twenty largest daily point gains and losses. Of the top ten daily market gains, two occurred in 2008, one in the Christmas sell-off of 2018, and seven in March of 2020. I wrote this article in January 2019, stating that after a decade of suppressed volatility, we are likely entering a multi-year regime of volatility above the 20 point VIX average. These volatility regimes begin in bear markets and extend for four or more years. The point here is that a historic daily point increase does not indicate that the worst is over. In fact, it usually indicates the opposite.
Now let’s examine extended bear market rallies. The next two charts provide a great visual representation of how many bear market rallies will occur and thus how many opportunities bulls have to claim the worst is over. The first chart is the 2000 bear market and the second is 2008. The red lines show the declines from peak to trough, culminating in 50%+ drops. The black lines show bounces from lows. In summation, the dot-com crash witnessed two 20%+ rallies en route to a 50% decline. The 2008 GFC witnessed a 28% rally before its final decline. The current rally may continue, but it is too soon for bulls to declare victory.
4. Who will be the buyers?
The chart below shows the four main buyers of U.S. equities. As made obvious by the chart, corporate buybacks have propelled valuations into nosebleed territory. Facing margin pressures, corporations will not have the extra cash flow required to purchase their shares. This occurs in every economic slowdown. Additionally, any company receiving a government loan from the recent stimulus bill will not be allowed to purchase their own shares until a year after that loan is paid off.
Households and institutions both face similar circumstances in that they will have less disposable income to spend on the stock market. Less individual investors will be inclined to put their money in the stock market given such uncertainty, less institutional investors will have cash to put in the stock market given increases in client redemptions, and a reduced labor force means less 401(k) contributions. Ironically, now is the time to consider putting money in the stock market as opposed to when the S&P reached record valuations. However, I do not foresee individual and institutional investors having the disposable income to place in the stock market given the dire situation on main street.
Lastly, this is a global pandemic. Foreign investors will not replace the reduction of domestic liquidity. With corporations not buying their own shares, 401(k) contributions diminished, institutional investors facing redemptions, and more.
5. The bond market is not buying it
The bond market sniffed out a recession before the epidemic. Yields peaked in October of 2018. While equities continued to rally, yields declined on continued expectations of rate cuts based on fundamental economic weakness seen in earnings, manufacturing, and consumer spending. While equities rallied 15%, bond yields fell another 40 bps. When bonds and equities first experienced divergence, bonds proved more prescient at foretelling the future. During this rally, bonds are showing skepticism by declining slightly while equities undergo a massive rally.
The first way to play this thesis is to de-risk. Use this as an opportunity to reduce equity exposure and expect another large sell-off. Use this cash to enter at a better level or to increase gold/bitcoin exposure. Aggressive investors can consider shorting the index or increasing volatility exposure.