Rallying In Face Of Disaster
U.S. economy is possibly on the brink of complete disaster. There is a legitimate shot of the first depression since the Great Depression in the 1930s. This is a lot like the 2008 financial crisis in that sense. Historically speaking, the 2008 recession wasn’t that bad. It was only bad if you start your analysis after the Great Depression. Stocks fell over 50% not because of how bad the recession ended up, but because of how bad it could have been. The entire financial system could have imploded.
Now we’re in an equally dire situation because if the economic shutdown doesn’t end in a few weeks, tens of millions of jobs will be lost. The situation is already grim and we’ve only been through one week of this shutdown. Goldman Sachs estimates there will be 2.25 million jobless claims in the next report. The economy is well on pace for a severe recession. This shutdown can’t keep going.
California issued a statewide stay in place measure and Pennsylvania mandated that non-life sustaining businesses shut down by 8PM each day. These actions will cause a cataclysmic recession. I’m not one to call for recessions, so you know this is serious. Despite the potential for an outright depression, stocks increased modestly on Wednesday and the futures market indicated a positive open on Friday. It’s very good news that stocks aren’t cratering when terrible reports come out.
However, don’t get used to this rally. Don’t think everything is ok because stocks are about to have their first 2 day winning streak in 25 days (record long streak is 28 days). A 29% decline in the S&P 500 does not price in a depression. We need to see stocks fall at least 40% in total.
Why Stocks Aren’t Cratering
Stocks aren’t crashing because the panic went too far. Bill Miller stated this week that even worse news needed to come out to sustain the level of panic in markets. Panic is an emotion just like anything else. It became exhausted this week. That doesn’t mean this decline in stocks is over. It just means we may have found near term support. There needs to be much worse news to send stocks down further. News that this shutdown will last more than 8 weeks would be enough to send stocks careening lower.
As you can see from the chart below, the percentage of bears has recently increased. In the week of March 18th, the percentage of bears actually fell 0.2 to 51.1. But it was still above the long term average of 30.5%. This was the first time the percentage of bears was above 50% in back to back weeks since March 2009.
Bad news is the percentage of bulls increased 4.6% to 34.4%. Despite the extreme volatility, the percentage is only 3.6% below average. That’s because almost no one is neutral. Everyone has an opinion on this market. Percentage of neutral investors fell 4.5 points to 14.5% which is way below the average of 31.5%.
Active managers are very bearish on stocks. As you can see from the chart below, the NAAIM average is 10.65 which is near the expansion low. 4 week average is lower than any point in the last 13 years. 3rd quartile of investors only has a 25% positive exposure to markets. This was 100% as of February 26th. There’s not much room for investors to become more bearish; this explains the selling exhaustion.
Sector Insanity
Even though the stock market rallied modestly (0.47%), under the hood the situation was anything but normal. This was quite the unusual day as utilities imploded along with muni bonds and investment grade bonds. While energy and small caps exploded higher. Energy sector rose 6.75% as oil rose the most on a percentage basis on record. WTI rose 23.8% to $25.22. Analysts discussed the possibility of negative oil prices earlier this week. That’s the type of negativity that catalyzes bottoms.
On the other hand, utilities cratered 5.47%. Consolidated Edison stock fell 13.13%. Prior to this decline, it was only down 2.52% from its recent peak. A few funds blew up and were forced to sell everything. There’s no reason the utilities should have fallen this much in one day. Safety stocks were clobbered. Wal-Mart fell 2.12% after hitting a record high on Wednesday. Consumer staples fell 3.34%. However, small caps did well. Russell 2000 was up 6.82%.
Bond Funds Blow Up
Bond funds blew up in epic fashion. Seemingly safe ETFs fell dramatically. Long bond fund and the short term investment grade ETF trade at -4% and -5% discounts to their net asset value. As you can see from the chart below, the LQD investment grade corporate bond fund had a bigger dip that in the financial crisis. Liquidity doesn’t exist.
Muni bond funds crashed partially because municipalities like New York City and Los Angeles are in trouble and partially because liquidity doesn’t exist in this market. VTEB national muni-bond ETF is down 18% since March 9th.
As you can see from the chart below, the different between AAA muni yields and treasuries is higher than the peak during the financial crisis. The dollar index has been ramping. It hit a 52 week high of $102.99.
COVID-19
Based on the chart below, hopefully Italy will start reporting good news on the number of cases in the next few days. Unfortunately, March 19th had terrible news as there were 5,322 new cases which is by far the most in a day. Previous high was 4,207. It’s amazing stocks rallied despite such bad news.
At least the number of daily deaths fell from 475 to 427. America had terrible news, but that’s expected for the next 2-3 weeks. The number of new cases rose from 2,848 to 4,530. Number of daily deaths rose from 41 to 57. Good news is most of the Florida beaches were closed and the number of national tests has exploded. There have now been 103,945 tests.
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