The business cycle is very simple to understand. It goes from expansion to peak to recession to trough, and then it starts over again. Sometimes in more severe cases, it goes from expansion to peak to recession to depression to trough, and then it starts over again. In March when the stock market caught up with the health crisis but led the economic crisis, it corrected into a recession. Most people were predicting it would be a short-lived, “V-shaped” recovery. They were right. This correction allowed asset prices to adjust closer to their true valuations. Now what we are seeing is something even scarier. Irrational optimism, retail investors with their stimulus checks, and the Feds with unlimited QE have brought the stock market almost back to their initial highs. The graphics below show a couple of outstanding data sets. The first is how uncorrelated the stock market is to their 12-month estimated earnings per share (EPS). The second is how many retail investors have been active in the market recently. The third is how much the Fed’s balance sheet has grown since this has all started; over $7 trillion.
The risks I fear the most are: a wave of new confirmed virus cases, more speculation in vaccines and less successful trials, an increase in white-collar workers becoming unemployed (unemployment insurance can not cover their lifestyle expenses), and the credit market bursting due to more bankruptcies, more credit rating cuts, and negative interest rates. What will happen when the Central Bank tools run out or more importantly, what will happen when their practices and tools stop working the way they are supposed to? The year isn’t even halfway over, and most lagging economic data still needs to be released like GDP. Only time will tell, but this market is looking more like a bubble every single day.
Uncertainty brings about confusion which brings about fear which brings about stagnation which causes missed opportunity. What we are thinking about now is what asset classes will be the most valuable in a couple of years and where will value come from? We are looking at REITs and other high-dividend paying stocks. With stock-buybacks decreasing and inflation being forecasted, your return will be dismal. Where will you get the extra percentage points to create Alpha?
Hindsight bias sucks because you can not use it, but great to learn from. From learning about how asset classes reacted to the current and past market conditions, I have learned many things:
- I would have shorted volatility when it spiked.
- I would have bought into tech, e-commerce (Amazon, Shopify, MercadoLibre, Alibaba), and retailers selling essential items (Walmart, Target, Costco).
- I would have bought more Gold.
- I would have shorted restaurants and airlines.
- I would have bought the March lows with more leverage than I did.
- I would have sold out of my VIX positions at the highs in the 70s. (^VIX)
- I would have bought Bitcoin lows in the $4,000s.
- I would have bet against the biggest hit foreign economies (Brazil, Italy, China, India, Russia, and the U.K.).
- I would’ve sold TVIX at a higher price above 700. I waited too long and got greedy, which I should not have done. I then would’ve bought back into the blue chip stocks, knowing that eventually the market would recover as it did
- I would not have watched the market everyday, because the past few months have all been give and take. Trump says something positive and the market goes up, new data says something negative and goes it back down. Rinse and repeat.
- I would have put more time into researching companies with strong financials to last or even thrive during a pandemic.
- Sold out of more of my less risky assets and allocated more funds to speculative stocks.
- Followed more pharmaceutical companies to capitalize on news of vaccines or new treatments.
We have learned much more and moving forward we will use what we learned to make smarter, more profitable decisions.
The ACA Foundation
War of the Worlds
Tensions between the United States and China are higher now than at any other point during the last three decades. As a result, the world’s two largest economics continue to clash politically and economically, increasing uncertainly in an already chaotic world. Despite being as economically intertwined as two nations can be, the U.S. and China have vastly different political ideologies and are often on opposite sides of geopolitical issues.
Starting with the trade war, the two nations began decoupling their economies, an action that had economic implications for nations across the world. As the trade war dragged on, Chinese firms found other markets to sell their products and U.S. companies found other nations to manufacture their goods in. China fell from the United States’ top trading partner to 3rd place behind Canada and Mexico and is not expected to regain its place anytime soon. Just as it seemed a lasting agreement had been made the world was blindsided by the novel coronavirus and U.S.-China tensions skyrocketed once more. Sticking to his nationalism sentiment, President Trump shifted blame from his administration's handling of the pandemic to the initial cover-up by Chinese officials. This created a nationalistic fervor in both nations with officials on either side accusing the other of false claims. As a result, increased tensions can be seen in the South China Sea (North Natuna Sea). The U.S. and China have both sailed naval vessels through the area as a show of strength. Conflict in this part of the world is recognized as one of a few flashpoints that could spark a massive international war. While displays of strength are common, both nations have also demonstrated more commitment to the area. This week the U.S. announced a sale of $180 million worth of torpedoes to Taiwan. This sale comes as both nations are drastically upgrading their militaries. The U.S. is midway through an ambitious plan to shift its fighting force to focus on near-peer enemies that includes upgrading almost every weapon in the U.S.'s expansive arsenal, while at the same time the Marine Core is disbanding most of its armor battalions to shift its fighting force to become more agile and able to quickly assault and take small islands in the South China Sea. China for the first time is preparing to outfit its troops with body armor and improve its training platform, both of which have long been considered major setbacks for the PLA. At the recent semi-annual meeting of party members, Chinese officials discussed plans to take a long-term approach to retake Taiwan through political means as opposed to military action, and a new security law for Hong Kong that may jeopardize the “one country, two systems” framework. These are just some of the events that the global markets are looking to for insight on relations between the two counties that make up approximately 40% of world GDP. Another important indicator is the weakening of the Chinese yuan which has reached the level it was at during the height of the trade war. In the near future we can expect more events like the U.S barring American companies from supplying Huawei as China retaliated for the striking blow to the telecommunications giant. These events will only accelerate the pace at which these economies decouple.
The ACA Foundation
In normal times, the stock market and economy are not correlated, but have more of a causal relationship. When employment is in full strength and GDP growth is increasing, we can expect companies to have stellar earning reports and distribute a gracious return to shareholders. Today, there is a huge disconnect between the stock market and economy where the economy looks more like a depression, but the stock market looks like it just started its next expansion. In this day, politics has more of a deciding factor on our stock market than corporate finance and economics. I say its too soon for this ambition rebound. The world is changing and will forever be changed. Globalization will look more like a risk than an opportunity. The equality gap will widen. Our health care systems will have to restructure. Our fiat currency system will be tested. Ultimately, there will be no market place (normal buying and selling) for a while.
The Fight Continues. As the United States presses forward with its battle against the novel Coronavirus, some Americans have grown weary of the economic consequences of the massive economic slowdown. Right now, more than 97% of Americans have at least some confinement guidelines set by their local governments while tens of millions are under stay at home orders. These measures have not only drastically affected the economy but also tested the patience of many Americans. This last week we have seen an increase in protests against safety measures even as the death toll climbs past 51,000. This begs the question, should the U.S reopen to minimize the economic impact at the cost of human lives?
Today, The US Congressional Budget Office announced that they expect the federal budget deficit to hit $3.7 trillion by the end of fiscal year 2020, making it the largest budget deficit since World War 2. They also estimate that the federal debt to GDP ratio will hit 101%. At the same time as government spending is heavily increasing, they predict the economy will contract by 5.6%, and unemployment will still be as high as 16% in the third quarter and average 11.4% for the year. By comparison during the Great Recession, unemployment peaked at 10% and the largest annual contraction in GDP was by 2.5%. Many other countries are also facing a grim economic outlook as the world has seen a severe decline in services, manufacturing, and global trade (shown in the figures below). As discouraging as the data is these circumstances have not been encountered in modern times and the possibility of a V-shaped recovery can not be entirely dismissed. So, should states allow businesses to reopen and people to get back to work? We will let you decide since it comes down to how much value you place on a human life.
Trump facing a hard path to victory as pandemic rages. With the upcoming presidential election looming large in November, President Donald Trump had seemingly laid out strategy similar to the one that brought him victory in 2016 against Hillary Clinton, full of delegitimizing attacks on reputation and catchy nicknames. This election calculus has been thrown into disarray with the onset of the COVID-19 worldwide pandemic. The present crisis has forced the president to act in a manner not often associated with his character, including working with Democrats to pass legislation, continually hosting experts who have publicly disagreed with his past statements, and attempting to make eloquent, scripted remarks to the entire American people, calling himself a “Wartime President.” While crises do have the potential to substantially increase a president’s approval ratings, they have just as much potential to dissuade previously enthusiastic voters of a president’s competence in the job. For his part, President Trump has mobilized national resources to respond to the pandemic and has overseen the deployment of military and emergency resources at a record pace. However, his initial response to the pandemic was unenthusiastic, with the president publicly blaming both the media and the Democrats for blowing the story out of proportion, before finally declaring a state of emergency upon him personally almost being exposed to the virus. His present demeanor has won him some support, as his approval rating has finally edged above 50%. However, he is still projected to lose to his Democratic counterpart, former Vice President Joe Biden, including in Fox News polling that shows Biden winning in Michigan, Pennsylvania, and Florida. The crisis has not helped Trump narrow this lead, though the election is still 6 months away, and much could change as election season heats up. While polls are not necessarily indicative of future election results, Americans have a tendency to rally around leaders during national crises, and Trump not receiving more of a boost during this time should trouble him, and his campaign greatly as 2020 drags on.
Not Taking a Position. With the equity market trading between a range of 35-50 VIX, the bond market volatility between 60-100 (signified by the MOVE index), and oil volatility near 175, it's a traders dream. The issue is we aren’t all traders, and can’t take full advantage, if any, of the constant price movements. A high volatility environment means that price changes are occurring much faster than usual, and trading time has been sped up. If you don’t have experience trading these markets, it's more likely than not, that you will be whipsawed back and forth and ultimately end up on the bad end of the trade. Personally, I don’t have time to sit and trade these markets the entire time, so I’m taking a position most people don’t realize exists, not taking a position. With unemployment nearing 20 million, businesses starting to go under, lockdown being extended to may, fed decreasing rates to 0% w/ nothing but cash left in the arsenal, and increasing the federal balance sheet to an unprecedented 6.6 Trillion, the market seems to still be pricing in a near best-case scenario being just 20% off 2019. “Markets can stay irrational longer than you can stay solvent.”
Opening the Economy. As people across the country begin to become more and more agitated with a government-imposed "quarantine" (protests, a general relaxation of strictness), it's very plausible to consider the pros and cons of opening the economy back up and resuming operations in a somewhat normal capacity. The pros of doing so are fairly simple and obvious. Opening the economy back up would, essentially, be as if nothing has changed. Of course, there would still be the massive layoffs that we have already seen, as well as a change in consumer habits. Nonetheless, if businesses reopened their doors, individuals would go back to work and continue getting a paycheck if they have not been receiving one during the quarantine. This means more money to spend on goods and more grease on the cogs of the economy.
What if it doesn’t go so well? What if there is a second, equally intense wave of infections in the fall (as global health organizations/professionals are predicting? What if we open the economy back up to early, and that second wave is even more intense, resulting in more infections/deaths? Surely, the impact on the economy could be even greater than if it were to just remain closed now. A few financial newsletter writers can't predict how a global pandemic is going to spread. But we can look at some of the logic surrounding the economy. If people stop working, stop getting a paycheck, and remain home, what will happen? Well, we're already seeing this now, but on a more long-term basis, it could lead to more deaths as people won't have the money to buy necessities and otherwise survive. That is, they won't have the means to survive without assistance, most of which will have to come from the government. Having already given out over a trillion dollars, many people are looking at the government to do more. How much more can the government handle given the current record debt and deficit levels? It would take a restructuring of the budget, we fathom.
In additional long term impacts, many small companies are closing their doors right now, never to re-open again. Filling that void of small businesses will be the giant conglomerates, leading to greater market share for those companies, and generally a greater capacity to manipulate the market and harm consumers.
The ACA Foundation
We ended this week lower, but this was expected. We were in a mirage from tech earning reports (the NASDAQ is only down -4% YTD) and continuous promises of stimulus from the Feds. Within the US, there is no value for the USD. Consumption and demand is decreasing, paying off debt and saving is happening more than spending and investing, and the government is LITERALLY giving away money. It is one thing for the government to give when someone needs and applies for it, and it’s another thing when they just give it without the recipient asking for it. Even with the funding, corporations and businesses will solve their short-term liquidity problems, but they will not solve their long-term solvency problems. States are beginning to open up their marketplaces, but at the risk of new cases. There is risk of retesting March lows and entering into a depression. With the disconnect between the economy and stock market, we can see the stock market starting to correct based on our current economic environment.
The Fed Minutes. The Federal Reserve echoed its previous statements this week. Jerome Powell reassured the global economy that the Fed would do whatever necessary to keep the market afloat and get us on the track to total recovery. If you were afraid that the Fed would be more limited and will only be able to offer a limited amount of help from a monetary quantity basis, fear not. Powell said that the Fed would absolutely not run out of money. Robert Kaplan, President of the Dallas Central Bank, reiterated this with a gloomier tone. He stated that the U.S. could be seeing a 30% decline in GDP during the second quarter, and that unemployment could rise to 20%. This is cause for another type of stimulus package from the government. Furthermore, Kaplan warned against disinflation, in which the rise in prices is slower than normal. This is looking likely for the next 1-2 years in the U.S.
A Nation in Limbo. The lack of informed and cohesive guidelines on how and when to reopen the country from the federal level has left cities, counties, and states arguing amongst themselves as more Americans grow inpatient. Unfortunately, reopening a country with over a million people infected with a virus that has killed 65,000 people is not as easy as picking a day and there is no right answer. Until significant progress is made towards a vaccine or treatment, the decision to reopen will be a trade-off between human life and economic well-being. Gilead Sciences Inc. is the top story of the week. Gilead is an American biopharmaceutical company that specializes in antiviral drugs used to treat HIV, hepatitis B and C, and influenza. As of this writing, their stock is priced at $79.95, they have a market capitalization of $100 billion, and they are up 22% this year.
Earlier today, The Food and Drug Administration on Friday granted an emergency use authorization to Gilead Sciences Inc.’s Remdesivir. Remdesivir is an experimental drug that was first used to treat Ebola. This means that the drug can be used outside of clinical trials to treat patients with COVID-19. Remdesivir has been used to treat other coronaviruses namely SARS and MERS and was used in China back in January to test its effectiveness towards COVID-19. Since January, the drug has been used in several trials across multiple counties and the federal research agency found that on average, Remdesivir shortened the recovery time of patients with COVID-19 from 15 days to 11 days. While this new treatment is promising, it should be noted that its effectiveness is limited, and is by no means the treatment that the world is desperately waiting for. Despite its limited effectiveness, it has the potential to save lives, and demand is extremely high. Gilead announced that they could spend $1 billion dollars developing the drug and already plan to donate 1.5 million vials. As you read this, 50,000 courses of the drug are being distributed across the country, and results are expected as early as next week.
Bitcoin Halvening. Bitcoin prides itself on being a depreciating asset, which means that over timeless of it is being created. This is done through a halving cycle, which occurs every 4 years. The next halving is in approximately 10 days. This means that the block reward, the amount is given out ever nth minute, will be cut in half. The current reward per 10 minutes is 12.5 bitcoin, which will fall to 6.25 in 10 days. Bitcoin is statistically interesting as at any minute you know exactly how many bitcoin currently exist, how many will be mined that day, how many will be mined that year, and the total amount that will ever exist. This in conjunction with the halving creates a predictable scarcity. The potential price impact from a block reward halving isn’t completely known, as this will be the first since BTC has gained such popularity. I will personally be watching the halving, which I’m sure will be interesting. It is taking place exactly on May 12th at 4:40 pm PST, on block #630,000.
Defense Production Act. In times of crisis, many governments have measures in place that allow the national government to take control of industries deemed necessary to address the crisis at hand, whether that be a war, natural disaster, or pandemic. In the United States, this measure specifically is called the Defense Production Act of 1950. Enacted during the Cold War, this law allows the federal government to force businesses to produce materials necessary for war, as well as allows the federal government to take over “vital industries,” specifically allowing the President to seize control of necessary companies and factories. Additionally, this act was used to mobilize resources to industrialize the country in industries deemed lacking, yet necessary, providing low-interest loans that kickstarted the domestic aluminum and titanium industries and channeling research funds toward the development of new defense technologies. Famously, the act was invoked to nationalize the United States’ steel industry during the Korean War, as steel unions had decided to go on strike during the conflict, threatening the war effort.
Meat Plants told to stay open to ensure food supply. In the wake of the COVID-19 pandemic, many meat processing plants had suspended or reduced operations following numerous outbreaks at plants across the country. This has led to a potential shortage of meat in the United States, and as a result, President Trump has used the Defense Production Act of 1950 to force them to stay open, as they have now been designated as “critical infrastructure” during this national crisis. This has been just one of the numerous times that President Trump has activated the Defense Production Act during the outbreak, as it was used previously to order General Motors to use their industrial capacity to produce ventilators for critical patients. The use of this act underlines how serious the impact of COVID-19 has been across the United States, with the federal government instituting wartime measures and record spending bills to address the burdens created by the pandemic.
The ACA Foundation
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.