The Senate and the House both voted to pass the $2 trillion stimulus bill. In the short-term, this stimulus will help the corporations, small businesses and individuals who are in need of money. It may help alleviate the lost revenue and damaged balance sheets in the short-term, but there will be huge ripple effects do to the unknown consequences. What happens when $2 trillion+ is printed and added to the US deficit? What will happen to inflation? What will happen when people realize they get paid more for not working? What will happen when the Feds have their printing machines constantly on?
Consumer confidence is down meaning they will stop buying goods and services. Consumers will stop spending money due to: a) the inability to buy due to the nationwide quarantine, b) the inability to buy due to being unemployed, and c) the shift from spending and investing to saving. Once they get free money (helicopter money) from the government, it won’t be used for investments and other spending. It will be used for the essentials of survival. And for the landlords’ sake, hopefully rent.
Earlier this month we experienced a liquidity shortage, tons of volatility, and forced selling due to a leverage unwind. Today, we see all asset classes fluctuating in confusion (USD, gold, silver, Bitcoin, public equity, treasuries).
You can trade the Market short-term by having open positions capitalizing on the highs and lows by shorting and buying short-term option calls/puts, but the store of value now are in Gold, Gold miners, and cash.
There is a tug-a-war between the Feds providing trillions of dollars in stimulus and asset purchasing and the virus spreading faster and more people dying/staying out of work and being unemployed.
In the short-term, massive amounts of outflows will continue and we will see short-term rallies and declines. Once the trillion dollar stimulus begins to distribute to its specified parties, we can see some more upside.
In the medium-term, we will enter a recession and we will see more downside. The virus is spreading faster and damaging more than people’s expectations. Fear will spike and chaos will erupt.
In the long-term, we will see ripples of the virus for years to come.
The Alchanati Campbell and Associates Team
This is not a regular “What’s up Friday?” Newsletter. This piece will discuss the current events occurring around the world and the current market reactions and price movements in the stock market. In short, people are panicking and grocery stores, Purell manufacturers, and virtual communication companies are thriving. Most economies around the world are easing their policies to allow their companies and societies to have some relief. Central banks around the world are offering more liquidity and more easement in rates. Governments are lending money interest free to businesses who have been negatively impacted by loss of business and soon we may see consumers getting handouts. Businesses are closing, losing revenue, and some businesses are going bankrupt. Oil is in a recession and assets like Gold, Silver, and Bitcoin are being sold off for liquidity reasons. Countries are announcing national emergencies and are restricting travel to try to stop the spreading. Schools are closing, public spaces are closing, public events are being postponed, and people are working virtually from home. I am currently split: I believe that there could be more selling, but I also believe we can see the market moving higher (as you could see from the buying spree today with a 9% increase). The selling has been caused for two reasons: irrationality and poor emotions (fear, anxiety, panic) and companies being downgraded due to future earning losses and/or being directly affected by the virus (cruises, airlines, retailers, restaurants, entertainment parks, travel agencies, manufacturers, etc.). My tips: be cognizant of your expenses, DO NOT SELL, buy back slowly at these lows and hoard cash to prepare to buy some more, do not try to time or play the market, plan for the next expansion, and if you have debt, focus on either paying it off or restructuring it.
“At the beginning of the last recession, the first selloff was in the summer of 2007 and totaled about 15%. The Fed cut rates aggressively and the market rallied to a new high in October right before the start of the recession in December. The second drop was from that October high to a March bottom 19.5% lower. Stocks recovered nearly 2/3 of that loss before hitting the skids again. Stocks managed a 15% gain after the onset of recession on (misplaced) optimism about the Bear Stearns deal. By that time our recession indicators were clear with the yield curve, credit spreads and the CFNAI all in agreement.” – Joseph Y. Calhoun III
“Buy, sell, or hold? I think it’s okay to do some buying, because things are cheaper. But there’s no logical argument for spending all your cash, given that we have no idea how negative future events will be. What I would do is figure out how much you’ll want to have invested by the time the bottom is reached- whenever that is- and spend part of it today. Stocks may turn around and head north, and you’ll be glad you bought some. Or they may continue down, in which case you’ll have money left to buy more. That’s life for people who accept that they don’t know what the future holds. But no one can tell you this is the time to buy. Nobody knows.” – Howard Marks
“Oil is like a wild animal. Whoever captures it, has it” - J. Paul Getty. More than 50 years later, Mr. Getty could not be more right. In addition to all the turmoil these last two weeks have brought to the global economy, Russia and Saudi Arabia are in an all-out oil war. For the past three years, Russia has worked with OPEC to set oil prices via production levels, but last week Russia decided to blow up the relationship and undercut OPEC’s price target. In response, Saudi Arabia has gone all out. Saudi Aramco plans to pump 12.3 million barrels of oil per day in April. That is 27% above their recent levels and 300,000 barrels above their maximum capacity! Oil was already struggling due to COVID-19, so why did Russia decide now was a good time to start a price war and lead the oil market into a free fall? US crude plummeted 26% which was its worst day since 1991. The answer is very simple. Russia saw a chance to deal a major blow to America’s fragile oil industry and they went for it. Back in 2018, the US overtook Russia as the world’s largest oil producer, and this was only made possible by shale oil companies. Shale is a high-quality oil and is produced by fracking. Since 2014, shale oil companies are responsible for the boom in domestic US oil production, but this growth is built on a massive amount of debt as most shale oil companies are over-leveraged or heavily in debt and rely on high oil prices just to survive. The much needed high prices could be easily undercut by other oil-producing nations, especially Russia which can easily balance its budget at under half the price needed by US shale companies. In recent years, Saudi Arabia with OPEC has helped support these higher prices and allowed the domestic US oil industry to grow to this level at the expense of Russian market dominance, but Russia has had enough. Now it is one big game of chicken that neither Russia, Saudi Arabia, nor the US will win. Short-term and long-term projections do not look good for the oil industry. In the long run, oil is set to be replaced by cheaper and cleaner energy sources, but in the short term, the worst is yet to come. It is unlikely that OPEC or Russia will back down so the oil market will continue to experience turmoil, but demand is not likely to recover in the coming months as global travel is restricted. In the meantime, some US shale oil companies may not be able to make it through the storm and some are even expected to file for bankruptcy by the end of the month, adding to the 208 shale oil production companies that have filed since 2015 and the 21 oilfield service companies that filed in 2019 alone.
The Alchanati Campbell and Associates Team
How crazy a month can do to markets let alone a week. We officially have entered a correction, but the question now is if we will enter a global recession. All 11 S&P sectors are falling, and the only shelter seems locked up in your house (for health reasons) and stored up in Gold (“flight to safety”). The market will continue to fall as long as the virus continues to spread, more people die, supply is restricted, travel is prohibited, and productivity is limited.
To Lever or Not to Lever. You've probably all heard the term "leverage" before. What does it mean? It simply means to take on debt to finance a project. The more debt you take on, the more levered you are. A logical reaction to this is, "Hey, why would someone/a company purposefully take on debt when they don't have to? Isn't debt the harbinger of doom?" This is where we believe societal connotations have failed society, at the very least in a financial literacy aspect. We have all been brought up thinking that debt is some horrible thing that should be avoided at all costs. While it certainly can be a problem if it gets too high beyond a corporation's reasonable ability to pay it off, it should be looked at in a neutral light. Debt is more important to the economy than equity/stocks. Debt is how corporations finance most of their projects. Debt is what allows tens of millions of Americans to own a house. Why take on debt? For a homeowner, it's easy to see. Most people don't have hundreds of thousands of dollars laying around to buy a house in cash. They take on a mortgage (aka debt) and they slowly pay it off. For a corporation with billions of dollars in cash/cash equivalents, why take on debt? To increase the rate of return. Say there is a new project for a company that has a cost of $1 million for a new facility. Say that, at the end of 5 years, the present value of the 5 annual cash flows equals $1.1 million. The project has returned ~10%. However, what if we used leverage and only put 70% of our own money down and took out a loan for the rest? We spend 700,000 and take a 300,000 loan. Now we have only spent 700,000 but we still generated cash flows of $1.1 million. Of course, we still have to pay the interest. Let's assume interest is $25,000 (in the real world the interest will be an annual/monthly rate that compounds, but this is a newsletter so let's keep it simple). So we have spent 725,000 to generate 1,100,000, which gives a return of 52%! That is the power of debt.
Dollar iliquidity Theory - theorized and popularized by Luke Gromen. Dollar Illiquidity, or a dollar denominated shortage, comes from a mismatch between supply and demand, with the later overpowering the former. When we are mentioning the USD, we are talking about all dollar-denominated safe assets, which are considered like-money. This idea of dollar liquidity can get very complicated, relatively fast, so we will leave it at this definition.
A dollar illiquidity crisis, in its simplest sense, means a dry up of liquidity. This results in a general decrease in loans across the board. The second derivative consequence leads to a rapid appreciation of the USD, leading to strain on international trade and net imports outside of the US. We recently saw a sign of this dollar illiquidity through our repo market, whose rate blew up to over 10% in late 2019.
Now that we have what it means down, we can get into how this has come about. The major underlying cause of this stems from directly after world war 2, when the USD replaced the British Pound as the new global reserve currency. The global reserve currency is a central currency which is held by a majority of central banks and other monetary authorities for the means of international trade, cross-country investments, and most aspects of the global economy. The global reserve currency cements that nation as the most fundamental aspect of the global system. This creates a large demand for our US greenback, increasing our dollar prices. Realistically, this in part, leads to the US being viewed as a safe haven during times of global doubt. This is net positive for the US, while being negative for the rest of the world. Hypothetically, this should allow the US to not only weight out a global recession, but should lead to increased risk-free and risky asset prices and further dollar appreciation.
The Death of Titan: “Neutron Jack”. Jack Welch who was the CEO and Chairman of General Electric from 1981-2001 passed away on March 1st, 2020. Mr. Welch was for many people the embodiment of what it signified to be a CEO. During his tenure as CEO, GE’s revenue increased nearly fivefold, skyrocketing the company to become the most valuable in the world. His success in leading GE allowed him to become one of the most well-known business leaders of all time, including making the cover of more newspapers and magazines than any other CEO. At the time of his death, Mr. Welch was worth nearly $750 million, but that was not for nothing. Over two decades for better or for worse Jack Welch lead GE to stardom during some of the most turbulent times in the American industry and helped shape what it means to be a “CEO”. Thanks to some innovative management and organizational strategies, GE’s value increased by $400 billion over 20 years. Mr. Welch pioneered the idea of “a boundaryless company” during a time when corporations put little effort into the corporate culture. In 1990, Mr. Welch introduced GE to his idea stating, “Our dream for the 1990s is a boundaryless company, a company where we knock down the walls that separate us from each other on the inside and from our key constituencies on the outside.” As a result, GE reduced the bureaucracy and instead focused on its employees. This led to a golden age of innovation at GE as it became a company that attracted talented employees who gave their all. Noticing the success this had, Mr. Welch doubled down on his idea and pushed for increased self-confidence among his employees. He gave many of his employees the word “manager” in their title, which lead them to take ownership of their work and see their projects through until completion. To work out the issues that would arise from having lots of passionate people work together GE held “town meetings”. Finally, in what was most likely his single greatest decision he "de-layered" GE. Like every large company at the time GE had grown to be inefficient and was weighted down by its hierarchical organizational levels. By reducing these layers, Mr. Welch reduced costs, minimized delays, and allowed GE to operate as efficiently as a small company while competing on a global scale. This strategy would go on to influence business leaders around the world, especially in Silicon Valley which gave way to a new generation of CEOs.
The Alchanati Campbell and Associates Team
The virus has caused the US market to crash around 12%, wiping out trillions of dollars. The 10-year dropped to its lowest, Gold had a steady climb but dropped back down today, so what is one supposed to do? I am going to state it very simple and blunt: Wash your hands and take care of your health; it’s the most important thing. If you have cash on the sidelines, cost average your positions and buy into favorable stocks at these lows. If you are a new investor, congratulations and buy into this “more affordable” market. If you have debt obligations, liquidate and have some cash for those expenses because who knows where the market is heading. Lastly, don’t panic but be cautious and smart. This is a historical learning experience, and this will build character and show your true colors.
Expansion or not, CEOs are sprinting for the exit. Over 1,500 CEOs have stepped down from their positions over the last year. Last month alone set a record for the most CEO departures in one month with 219 leaving their positions. The U.S hasn’t seen this many departures since the beginning of the great recession in 2008, so why are so many CEOs stepping down during a period that is often referred to as an unprecedented period of economic growth? It is very difficult to say since many CEOs have stated varying reasons. Here are some notable CEOs who have recently stepped down; Bob Iger of Disney, Keith Block of Salesforce, Tidjane Thiam of Credit Suisse, Les Wexner the longest-tenured CEO of a Fortune 500 company (L Brands), Dennis Muilenburg of Boeing, Matthew Levatich of Harley Davidson, and Ginni Rometty of IBM announced she will step down in April. Several business consulting companies, and corporate governance groups have been following this trend and have some ideas. First off, many of the CEOs have been involved in recent corporate problems and were forced to step down as was the case for the former CEO of Boeing and former CEO of Credit Suisse. The #MeToo movement has also played a large and has lead to the resignations from the former CEOs of CBS, and McDonald's. Both of these circumstances show an increase in corporate accountability, in large part due to new social pressures placed on corporate boards. Another theory is the growing concerns of an impending recession which may cause some officers to step down with their corporate legacies intact, basically, they want to quit while they are ahead. Whatever the cause there is an undeniable outcome. Over 2,000 large corporations have CEOs that have only just filled their position within the last 2 years. This does not mean they are inexperienced business leaders, but they will need time to adjust to their new positions which will likely be more difficult than usual thanks to factors like increased international tensions, political turbulence, and COVID-19. On the bright side, this mass exodus of CEOs is allowing some space for a new generation of corporate leaders and increase equality since the number of women filling the open positions has more than doubled from just a year ago.
Treasury Yields. US 10-year treasury yields hit an all-time low of 1.127%, as of closing on February 28th 2020. We are seeing an unprecedented amount of capital flowing into US government debt, only growing with the corona virus fears. This capital is seemingly coming from domestic smart money - pensions, hedge funds, and asset managers. Investors are seemingly fine with earning such a low yield rate, with the top 100 pensions having upwards of 50% allocation in fixed income, up from 25% in 05. With this recent market sell off, it seems retail investors are also moving into these risk free instruments, seemingly once again late to the party. Although this yield seems low, a good portion of the developed world is currently in negative interest rate territory, where you are seemingly paying the government for safe harbor. With this recent fear, and the recent statements by Jerome Powell and Donald Trump, regarding further fed rate cuts and possibly going into negative territory, many fund managers believe we will see this 10 year treasury rate declining closer to 0. Personally, I’m betting that this corona virus pandemic doesn’t last past Q2, and the equity market will make a swift recovery.
Navigating a Recession. To be clear, we're not calling the current situation in the U.S. Equity Markets a recession. Nevertheless, it’s impossible to ignore the facts. This week has been the worst since 2008. The S&P 500 encountered a correction within a single week. All the gains from 2019 have been wiped out. The question is, how do you optimize your allocation of capital during a time like this. If you ask Warren Buffet, he'll give you the ol' "Time in the market beats timing the market". He's also the most famous investor of all time. Generally, people want to move from riskier assets like large-cap equities to safer assets. These safe assets typically include Gold, Bonds, and certain currencies. However, things are a little different this time around. As we know, the Fed has been cutting interest rates over the past year or so. Whether you agree with their decisions or not, it’s hard to argue against the fact that their actions have led to some wacky yields on bonds. As of now, short term T-Bills (bonds with a maturity of 1 year or less) are inverted with the yield for the 10-year treasury bond. Without getting too deep on the recession indicator implications of this, it implies that people generally have lower faith in economy in the near future. So, maybe the safe assets such as long-term Treasury Bonds are not a good place to move right now. That leaves us with Gold. Usually, the price of gold goes up during red weeks as it’s a "safe haven" to move cash into. This week however, gold has plunged. Why? Without knowing for sure, it seems panic is truly setting it. Something similar occurred during 2008 in which investors sold anything they could just to have cash, the safest of assets. Obviously, this massive sell off will lead the price of gold down. Hindsight is 20/20, and it’s impossible to be certain of the best decisions to make when the world seems to be falling down. All we will say is there is a reason that Warren Buffet is regarded as the world's smartest investor.
Democratic Socialism. A political concept of economic organization requiring relatively heavy involvement of the government in the economic affairs of a nation. While more free-market oriented than socialist regimes, democratic socialists tend to require that large industries are at least partially government or union controlled, while levying large corporate and consumption taxes to finance generous safety nets for citizenry. Importantly, democratic socialists are committed to democracy and the ideals surrounding it, meaning that these regimes generally do not tend toward authoritarianism. However, heavy state involvement in economic activities does allow the government to play a more direct role in citizens lives, often leading to increased regulation, higher tax rates, and the potential for even more far-reaching economic measures, such as direct state ownership of key industries.
The rise of Bernie Sanders in the Democratic party. The most prominent socialist in the United States, Bernie Sanders, has recently been portrayed by many news organizations as the most likely nominee of the democratic party in the upcoming presidential election. A member of the Democratic Socialists of America, Senator Sanders is the longest serving independent in the United States congress, serving the state of Vermont since the 1980’s. Until recently, Senator Sanders has been considered on the fringe of American politics, with traditional socialist policies failing to win wide appeal. However, the 2008 financial crisis prompted a radical shift in the politics of younger Americans, giving the senator a large enough power base to launch a national campaign, coming in second to Hillary Clinton in the 2016 Democratic primary. Sanders has promised new regulations on the financial industry, as well as universal healthcare, free college education, and the erasure of student debt as his signature policies. Unfortunately, these new government programs would require large new taxes on all Americans, including the middle class, and would still likely require deficit spending in the federal budget, even as the federal debt of the United States reaches record levels. In a recent poll, only 28% of Americans said they had a favorable view of the term “socialist,” and a Sanders candidacy in the general election would likely prove nearly as divisive as the Trump campaign, as his policies sharply divide the nation. The senator has used polarizing terms when campaigning, framing his potential election as a “revolution” of the political class, alienating many Americans. Regardless of his potential weakness in a general election, Sanders has won the most primaries of any Democratic candidate up until this point, as his base of support has shown active in voting in primary elections.
The Alchanati Campbell and Associates Team
WHAT'S UP FRIDAY? is a weekly newsletter that will give you a summary of "What's up?" on Wall Street, in the US and around the World written by The Alchanati Campbell and Associates Team. What makes us unique is we focus on long-term knowledge; knowledge that will still be useful to you 10 years from now.