The stock market is refusing to drop lower!! Even with record amounts of cash in money markets and on the sidelines, the stock market is either stagnant or moving higher. (Graphics 1-3). The US stock market is discounting a new expansion in its price while we only just began a major recession. The problem we are facing now is another rise in COVID-19 cases, which means tighter regulations, fear spiking, and lockdowns and hibernation beginning again. The US economy can not face another shutdown. Even though large corporations, like Apple, are shutting down some of their stores…again, small companies can not face any more economic shock. I am very certain that the rise in virus cases are due to three factors: 1) more testing, 2) the protests caused and are furthering the spread, 3) the weather is becoming hotter and while the hot weather was supposed to kill off the virus, people are staying inside with the A/C blasting and are becoming infected. The Federal Reserve pumping billions of dollars into the market is causing the market to stay-in-place; stagnant. (Graphic 4) Soon we may see what happens when the Fed stops the capital injections or slows them down. The Fed buying does not prevent defaults and it just shows how low long-term returns will be.
Chapman hosted an economic webinar Thursday, June 18th to discuss the monetary credit and fiscal responses to the pandemic. They had many panels of speakers ranging from the President of the Federal Reserve Bank of St. Louis to economic professors at MIT and Dartmouth College. The common themes between all the panelists are fear, uncertainty, this event is unprecedented, and it not being a V-Shaped recovery. Some agreed that the Feds made the right choices in their monetary and fiscal policies, but others had mixed feelings and felt that the Feds could have acted differently (bringing rates to negative). Here are the key takeaways:
Where we are now in the monetary and fiscal world is in unchartered waters and the current goals of the Feds are to mitigate a financial crisis and to mitigate depression risk. So, the Feds will do whatever it takes. Their current policy response comes in three ways:
The Cares Act essentially spent 10% of the US GDP to fund some of these policies. The prediction is the 2020 GDP will be 10% lower than 2019 GDP levels. But there will be more fiscal policy going forward because the stock market is being propped up by it, and society is relying on it. Unfortunately, this can not be maintained over a long period of time. The Feds estimate that, because a typical small business can not last 90-120 days without revenue, this is how long it will last.
One economist created illustrative scenarios to predict what may happen in three different ways.
The Feds are currently buying corporate bonds and corporate bond ETFs (regardless of their credit rating). For example, they bought an ETF fund (SPDR Bloomberg Barclays High Yield Bond ETF) composed of high yield corporate bonds… junk. Some say the Feds are going to start buying equity in the stock market. Are the Feds picking winners and losers? Will the Feds hold these corporate bonds to years to come? Will they become majority shareholders with controlling interests and voting rights? Who will they send to represent them at the shareholder meetings?
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Two simple words with a very impactful meaning: reality check. That is what dumb and smart investors experienced on Thursday when the indexes tanked -6%, but mostly the retail investors. (Graphic 1) Before Thursday, optimism was at all-time-highs, the market rebounded to its former highs, and the put/call ratio was at its lows (calls outnumbered puts). (Graphic 2) What caused the drop? A resurgence in new COVID-19 cases (mostly caused by states reopening too early and the recent protests)(Graphic 3), jobless claims still increasing by 1,542,000 (total of 29,505,027 for the week ending May 23), President Trump losing control of the social, political, and economical environment in the US (Graphic 4), and THE CORRECTION WAS LONG OVERDUE. The National Bureau of Economic Research determined that the peak (which marks the end of the expansion and the beginning of a recession) in monthly economic activity occurred in February 2020. (Graphic 5) What we are in is called a recession (and soon to be a depression), where volatility is high, and market-swings are frequent. What will happen is: as more economic data is released (painting a dark, ugly picture of our economy), the stock market will behave more correlated to that information. We will retest the previous lows and we may drop further. Volatility is back!!
“Weaker demand and significantly lower oil prices are holding down consumer price inflation.” - FOMC Statement
For the third day in a row, the market has shown losses across the board following the Fed’s monetary decision. Here were the key takeaways.
“The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.” - FOMC Statement
The Fed has many tools at its disposal but quantitative easing, yield curve control, and setting the federal funds rate are the most widely discussed and used tools today. Quantitative easing and yield curve control both involve pushing out or creating money to buy bonds. QE is when the Fed injects liquidity into the system through the massive purchase of bonds on the open market. In doing so they intentionally bid up the prices of bonds and reduce long term interest rates and borrowing costs. Yield curve control is when the Fed sets a long-term interest rate target and buys as many long term bonds as it needs to achieve that target. This is different than simply setting the federal funds rate. Proponents of the using yield curve control argue that the Fed can achieve lower interest rates with a smaller balance sheet than with QE. This would allow the Fed to not exhaust its resources and therefore be able to turn to other tools if needed. With the Fed balance sheet at $7.2 trillion yield curve control may allow the Fed to stimulate the economy while keeping a relatively low balance sheet if bringing the short term rates to zero is not enough.
Options Theta - Time Decay
Theta, or how I learned to hate time decay. Theta is a first-order effect measuring the decrease in the options price due to time. This effect is usually called time decay, as the options price decays as it gets closer to expiry. When buying options, this usually has the most detrimental effect on a stagnating stock price, as it always exhibits negative properties. While it is a burden when buying options, the reverse holds true while writing options. An options price has two main value components, its intrinsic value, and the time value. The intrinsic value is the current amount the option is in the money or above/below the strike price. The time value is the rest of the price, which is the time left for the potential option to get further in the money, or just become profitable. With this added time value, it is almost always more profitable to not exercise an option early. This however does not mean its a bad idea to lock-in the current gain by offsetting the position or selling the option in the market.
Smart Money vs. Dumb Money
In the bluntest way possible, "smart money" is exactly what you would expect it to be. It's capital injected into the market by "smart" people. What determines a "smart" person when it comes to investing? Anyone in any organization with some sort of track record or respect. The trading desk at Citibank, a mutual fund, a hedge fund, Warren Buffet, Ray Dalio, and the list goes on. People or corporations with experience, special analytical skills, and perhaps some industry information not available to most ordinary people (edge). "Dumb Money" is made up of everyone else (retail investors). You, me, my dad, my third cousin, my neighbor Jerry. We're just retail investors that do not have access to large amounts of data, nor do most of us have the time, skill, and drive to match the analysis of these large institutions. Any move made by an institutional investor is considered smart money.
But should it be?
There is little evidence that shows institutional investors, people whose investments would be deemed "smart money", are performing better than the other "dummies". Over the past 15 years, less than 10% of hedge fund managers beat the S&P 500. So, my neighbor Jerry can park most of his money in an index like the S&P, and then play around with some smaller trades on the side. Barring any extreme circumstances, Jerry's portfolio/401k is going to outperform a hedge fund any given year (except the Renaissance Fund, but that’s not fair).
It's also important to remember that smart money investors have some systematic advantages. Institutional investors represent over 70% of the market investments. Some corporations are trading with billion-dollar portfolios. The sheer volume of capital is enough to push prices in their positional direction. Moreover, they have the advantage of being viewed as "smart". Any trader from J.P. Morgan can write a piece on some stock saying how it’s a great buy. They can use some figures they pulled off a Bloomberg terminal (with a cost of tens of thousands of dollars per month), and convince some less Finance-savvy folks to listen to them. After all, they work for a giant bank and have connections with market mavens (people that are "in the know"). So we should listen to them, right? Not exactly. If they write a piece on XYZ stock, people will see it and then decide to buy it, thinking that since this analyst wrote about it, it must be good. The influx of capital from people buying the stock solely based on the article is enough to push the price of the stock up, thus making the article predictions come true. It is a self-fulfilling prophecy. Maybe XYZ stock is truly a great buy. But be wary of anyone that tells you they know for certain that this stock is the next big thing. They're trying to convince themselves just as much as they're trying to convince you. Then, there's the whole issue with banks engaging in market manipulation. Purposely releasing information to the public to drive prices up so they can unload their bad investments at a profit (looking at you, JPM). They'll stay stuff like "This stock is an automatic buy at this price" or "The sell-off has gone long enough".
On August 20th, 2019, JP Morgan upgraded Beyond Meat ($BYND) to a "BUY". This is purely hypothetical: They probably did this because they were riding the ridiculous climb of the company, one in which was easy to tell is a farce if looking at any analytical figure. Once the stock started to fall, they realized they needed to exit. So they released information to pump the price, and once it got above their average cost/desired profit point, they sold. Once they released their upgrade, the stock popped 14% on the next trading day. That pop lasted all of two weeks before plummeting further.
The takeaway here: Do your own Due Diligence. Don’t listen to advice simply because it comes from someone deemed by society to be "smart".
Just like hype and FOMO in luxurious retail and adventurous vacations (two examples), there is hype and FOMO in investing. It’s the newest factor to be used when evaluating market risk. The amount of retail investors joining the market has been “unprecedented”. Below is an example of the swarm.
One reason for this is consumers are using their stimulus checks and unemployment benefits to either save or invest. Below shows both scenarios.
These are due to consumer spending going down and personal “income” going up.
The issue of financial illiteracy looks like it’s being resolved (maybe) and finally the ownership of stock is not only in the top 10%’s hands, but there are many consequences and risks of this.
We have added to our list of risks. If any of these risks become extreme enough, we believe that we can see another correction in the market. We still hold the view that we are in a recession, and as history has shown, there is extreme volatility and movements in both directions. (Testing and retesting the highs and lows).
QE. Quantitate Easing is a modern monetary tool used by the federal reserve as a backstop for the economy. It was first used in the United States during the 08 financial crisis by Ben Bernanke. QE is the process of purchasing government bonds and other financial assets in order to inject capital into the economy, for the purpose of stimulating the economy and encouraging consumption. QE is usually only implemented once fed rates reach near the 0% mark as a final effort. This process usually increases inflation and can help pull the economy out of a recession. More importantly, the real affects this has on our economy has to do with increasing liquidity, increase in risky asset prices, currency depreciation, and signaling. The most important of these is the signaling effect, or as some call it the fed put. This is a psychological impact which is derived from the thought that the fed will take extraordinary steps to keep the market and economy afloat. Most market movements occur directly after the announcement of QE, with the actual QE taking place weeks/months after the announcement. This delay is due to government inefficiencies (time it takes to announce vs the time it actually takes to act).
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"Protesting is a part of your given rights as a United States citizen listed in the Bill of Rights under Amendment #1:
Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press, or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.
You should have your cake and eat it too. You should practice what you believe in. You should protest when you feel you need to express something on a grander scale. You should voice your concerns and suggestions. Our system should be flexible and adaptable to the changing eras. But violence and destruction is never the right answer. It's not effective and it will only widen the divide."
- Camden Alchanati
Gov. Gavin Newsom declared a state of emergency in the city and county of Los Angeles shortly before midnight, Saturday, May 30th, and activated the National Guard to assist police after two days of violent demonstrations, sparked by the death of George Floyd, an unarmed black man who was pinned down by the neck by a white police officer in Minneapolis. Los Angeles had just experienced a level of chaos and unrest not seen since the LA riots of 1992.
How did we get here?
Yesterday, I met with freelance photographer Jackson Deakins to capture the events firsthand as they unfolded and see how peaceful protests turned to violent riots.
I parked several blocks from the protests in a residential area, as I turned the corner towards the Fairfax district evidence of conflict was clear. I was surprised to find that two blocks from the protests, the presence of tear gas in the air was already clear as it had no trouble getting through my N95 mask and causing my throat to burn. Pushing forward, I passed dozens of protesters who had noticeably been there all day, heading home, soaked with milk, and tears still running down their faces.
I walked onto Beverly Blvd; a street best known across the world for its luxurious shopping, but I was met with a scene of absolute chaos. A small group had led a crowd of several hundred protesters right up to the police line and marshaled chants true to the memory of George Floyd. Hundreds could be heard chanting; “Black lives matter”, “I can’t breathe”, “George Floyd”, and when police took aim with their rifles, “Hands up, Don’t shoot”.
Dumbfounded with the situation at hand, I made my way to the front where I could observe the crowd of protestors. Before I could establish my bearings, there were several loud pops from behind me, followed by the sound of rubber bullets flying by, and a sharp pain in my shin. Canisters landed in the crowd and soon the air was thick with gas illuminated by the explosions of flash grenades. My face was stinging, each breath set my throat and lungs on fire, and true to the name my eyes filled with tears. As I ran for cover, I was met with a stranger who offered an eye solution and milk to neutralized the tear gas. This is when I took notice of the true sense of community. Rather than an “every person for themselves” mentality, people rushed to the aid of complete strangers. I noticed that protesters left granola bars and packs of water in various sections of the protests. People helped each other to cover or even stood as shields to block the barrage of rubber bullets and paintballs (used to mark individuals to be arrested later).
As tensions rose some protesters took on self-assigned roles for the benefit of the crowd. People grabbed cones to cover tear gas canisters and pour water on them, others ran around with first aid kits to assist the injured, a group of seasoned protesters tried to stop others from throwing objects and escalating tensions, and on the front line older protesters without eyewear or masks did what they could to keep other protesters and police from clashing. There are very few times that I have ever experienced this large sense of unspoken camaraderie.
Unfortunately, violence was present on both sides of the protests but not to the extent that it is focused on by most news media organizations. In the local and even international news coverage that I have seen the overwhelming focus is on the looting. The area I was in was several blocks from The Grove where there were scores of looters and was a completely separate crowd from the people there to protest. In my area, it was clear that over 90% of the people there were there to protest in a manner that showed their frustration after centuries of inequality but also in a way that did not escalate tensions, but there was no professional news team insight to capture this. In fact, the majority of the officers there also did not want tensions to escalate and I often heard officers yell at others to stop firing and to be careful of the protestors, serval even conducted peaceful conversations with the protestors, but the sad truth for both sides was that it only took a few people to bring both sides clashing together.
One incident, in particular, stood out to me. Four police officers with assault rifles had set up onto a building at the corner of the intersection. One officer would tap another on the shoulder and direct him to fire upon a particular individual who was often throwing something or starting a fire. This routine continued except when a lone African American man in his late thirties stood in the center of the intersection. This man had his hands in the air and clearly had no weapon nor was he antagonizing the police. Prior to this, I had seen this man do anything but peacefully protest. Despite all of this, the officers on the roof open fire on him, sending a barrage of rubber bullets hitting the man multiple times. His only response was a simple shrug to the officers, as to simply say “why?”.
After hours of tic for tat instigations that resembled waves crashing on a beach, tensions reached a boiling point. Heavy reinforcements arrived and there were now over 100 police officers attempting to control a crowd that had grown into the thousands. Squad cars drove through the crowd to break it up and the police made one sweeping push through Beverly Blvd, sending the protesters onto the residential streets with no police presence. At this point officers in full riot gear had taken over and used excessive force to push the crowds far into the residential areas. From the side street, I watched as a police officer took aim at a young woman from 15 feet away who was on her knees holding a sign, and just before I was pushed to the side by a crowd running for cover, I saw the officer open fire.
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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.