Infected Markets

You better make your face up
In your favorite disguise
With your button down lips
And your roller blind eyes
--Pink Floyd

Wild week on Wall Street was one for the record books as markets became infected with coronavirus fear. One of the largest single week declines in history:

Ten year T-note yield closed at all time lows as investors seek refuge from contagion:

With the virus and associated headlines unlikely to subside any time soon, next week's action should be interesting to say the least.

Whippy Trippy

"We went like this. He went like that. I said to Hollywood, 'Where'd he go?' And Hollywood said, 'Where'd WHO go?'"
--LTJG Henry 'Wolfman' Ruth (Top Gun)

Whippy trippy am that saw the Dow down another 1000+ at one point on chunky volume and big up/down moves by the minute. The bulls have tried to lift them higher with the COMP in the green at one point.

It 'feels' like we might need another whoosh lower to make way for a tradeable bottom. On the other hand, oversold extremes are registering on multiple gauges.

As such, anything seems possible here.

Never Before

Never say never
At heaven's elevator door
--Vanity

Never before have the Dow (-1191), SPX (-138), or COMP (-414) lost as many points on a nominal basis as they did today. Never before has the 10 yr T-note yield closed as low as it did today (1.299%).

After the pounding we've seen so far this week, a significant oversold bounce wouldn't surprise.

Correction Analog

"1929. As the dizzy decade nears its end, the country is stock market crazy. The great and the humble...the rich man and the working man...the housewife and the shop girl. All take their daily flier in the market, and no one seems to lose. Then like a bombshell comes that never-to-be-forgotten Black Tuesday, October 29. Confusion spreads throughout the canyons of New York's financial district. And men stare wild-eyed at the spectacle of complete ruin. More than sixteen and a half million shares change hands in a single day of frenzied selling. The paper fortunes built up over the last few years crumble into nothing before this disaster which is to touch every man, woman, and child in America."
--Narrator (The Roaring Twenties)

In summer of 1929, the Dow reached the apex of the Roaring Twenties stock market move with another all time high, running up nearly 80% from Jan 1928. It then quickly fell 10%--and then a lot more during the October crash that marked the event that would usher in the Great Depression.

Since the Dec 2018 lows, the present-day Dow ran over 30% to all time highs a couple of weeks ago. Since then, it has quickly fallen about 10%--which tags this market as the quickest to register a 10% decline since the 1929 analog.

Not apples to apples to be sure, but worth keeping in mind.

Income Providers

Katherine Garrison Geary: Oh, Ed, what do Alice or I know about newspapers?
Ed Hucheson: It gives you an income.
--Deadline U.S.A.

To the extent that earnings yield translates into dividend yield, chart shows why bids are unlikely to be completely lost under dividend-paying stocks in today's market environment. In fact, would think chart of SPX dividend yield vs bond yield would show a similar pattern.

Spread between S&P 500 earnings yield & BBB corporate bond yield widest since 2014 @SoberLook @bloomberg pic.twitter.com/vZcYaDgQY1

— Liz Ann Sonders (@LizAnnSonders) February 26, 2020

If you're looking for investment income, and you're not particularly sensitive to changes in principal/account value, then dividend-paying stocks seem a good deal relative to fixed income. Stocks are generally far more capable of providing income in today's world.

Key is finding dividend payers where yield is likely to be stable/growing even in difficult environments.

Ugly Times Ugly

"Right now, it is ugly times ugly."
--Gordon Gekko (Wall Street: Money Never Sleeps)

Two straight ugly days as the Dow lost nearly 900 pts. Breadth was quite negative. For the first time in a long time, every stock on my screen was red on the day.

Technical position of the indexes is interesting. Today's selloff resulted in the Dow breaking its uptrend line off the Dec 2018 lows:

The SPX has fallen to its uptrend line but remains unbroken:

The COMP is still far above its trend line:

Because its last leg higher was driven by lots of momentum plays, the Nasdaq requires more ugly just to catch its uptrend line.

Ten Year Record

Drawn into the stream
Of undefined illusion
Those diamond dreams
They can't disguise the truth
--Level 42

Ten year yields marking all time lows this am.

The 10-Year US Treasury Yield just hit a new all-time low: 1.33%. $TNX pic.twitter.com/9ucFJkmt49

— Charlie Bilello (@charliebilello) February 25, 2020

'Risk off' trade has full head of steam.

Is Green Good?

Bill Harding: Going green.
Dusty Davis: Greenage
--Twister

After yesterday's 1000+ pt down day on the Dow, futes are in the green this am. While this takes some pressure off bulls' minds, not sure they are best served by a positive open.

Meanwhile gold is being sold. Will personally be looking favorable spots to add on weakness in the metals complex today.

position in gold

Record Low Yields

She's got a heart of gold
She'd never let me down
But you're the one who always turns me on
You keep me comin' 'round
--Bryan Adams

We're flirting with all time 10 yr yield lows.

The record closing low was 1.37% marked back in July 2016. Currently trading slightly above 1.38%.

no positions

Going Viral

"I gave it a cold. I gave it a virus. A computer virus."
--David Levinson (Independence Day)

Coronavirus contagion outside of China has world markets in sell mode. Europe off ~3%. Although futes have bounced a bit, Dow still indicated down ~800 and SPX off ~90.

Gold up $30 to about $1680.

position in gold

Monetization and Prices

I never meant to be so bad to you
One thing I said that I would never do
--Asia

Suppose the Fed, thru its debt monetization activities, creates $1 million out of thin air to buy some bonds from one of its primary dealers, JP Morgan (JPM). The Fed lifts $1 million worth of Treasuries, agencies, et al from JPM's inventory in exchange for the newly minted cash.

Being a financial institution, JPM is likely to put the money to work thru lending or investing activities. Let's say that JPM uses the $1 million for proprietary trading in stocks. It might even lever up its trading capital to get extra bang for the buck.

Regardless of how it is used, the bulk of the $1 million remains in the financial system somewhere. Unlike credit money that exists only as long as the borrower has appetite for leverage, money created for monetization purposes persists unless/until the Fed reverses its initial transaction and sells its bonds on the market--at which time the Fed reclaims and retires the $1 million that it had previously printed.

As expected, the $1 million that JPM deploys causes prices to rise while it is in the market. But because JPM and other financial institutions are the early beneficiaries of the newly minted cash, it is primarily the prices of financial assets that rise. Stocks, bonds, real estate...whatever the banks buy with the $1 million go up in price. Importantly, as long as financial assets go higher in price, most of the $1 million dollars of newly created money remains locked in the financial system.

This is why we do not see broad consumer price increases from central bank monetization activities--at least initially. Financial assets prices can shoot toward the moon (as we have seen) while the prices of break and milk remain relatively stable.

If for some reason prices of financial assets begin to fall, then the balance might shift. Lower prices will drive investors to sell and pull money out of the financial system. When this occurs, the $1 million is released from the financial system begins to make its way into the every day economy.

This is when we'll see the price of goods and services rise in earnest.

The formal propositions are as follows:

Proposition 1a: When money is created for central bank monetization activities, the printed money will be used by financial institutions to buy financial assets, thus driving asset prices higher.

Proposition 1b: When prices of financial assets subsequently decline, the printed money rotate out of the financial system into the everyday economy, where it will be used by consumers to buy goods and services, thus driving consumer prices higher

no position

Energy Infamy

Evelyn Johnson: And, if you have a fault, which you obviously don't, it's modesty.
Rafe McCawley: No, if I have a fault, it's candor.
--Pearl Harbor

Last time energy stocks in the SPX were this low relative to the overall index was late 1941.

The beaten down energy sector is facing Pearl Harbor once again. Feels like we're either facing the end of the sector as we know it, or a rare investment opportunity.

Narrowing Names

After three days in the desert sun
I was looking at a river bed
And the story it told of a river that flowed
Made me sad to think it was dead
--America

When stock market rallies get long in the tooth, breadth tends to narrow. Traders swap out of names no longer working into the few that still are.

Here's a tidbit. Over the past *3* months, fewer than 40% of S&P 500 component stocks have beaten the index.

When the S&P was at a 52-week high at the time, this is the fewest % of outperformers in at least 15 years.

The only other days with < 40% were in October 2007. https://t.co/suswHMQsJA

— SentimenTrader (@sentimentrader) February 20, 2020

This time around stocks left standing include the familiar FAANG suspects plus names like Microsoft (MSFT) and Tesla (TSLA).

When traders leave these names, there will be no horses left.

no positions

Disorderly Move

Now did you see the news today
They say the danger's gone away
But I can see the fire's still alight
Burning into the night
--Genesis

The breakout move in gold continues. The yellow metal is up another $29 in early trading.

Remember that gold is a bet on disorder.

position in gold

Freedom at the Door

I want to fly like an eagle
Till I'm free
Fly through the revolution
--Steve Miller Band

Hard not to smile at this pic as winter gets long in the tooth, er beak.

just an average winter day in Decorah, Iowa pic.twitter.com/tSutwTmNuj

— David Burge (@iowahawkblog) February 19, 2020

When birds of freedom greet you at the door, you know it's going to be a great day.

Gold Breakout

When situations never change
Tomorrow looks unsure
Don't leave your destiny to chance
What are you waiting for
--Swing Out Sister

Pretty breakout in gold as it moves higher out of a classic cup-and-handle setup. Spot gold now resides above $1600/oz--a level last touched in early 2013.

Perhaps investors are catching on to the gargantuan quantity of monetary stimulus being injected by central banks worldwide.

position in gold

Lagged Effects and Uncertainty

"Why can't they invent a shot that keeps time from passing?"
--Jory Emhoff (Contagion)

The CoronaVirus situation presents good examples of lagged effects. It takes at least 10 days, perhaps longer, to diagnose someone with the virus. That means that infected individuals can unknowingly spread the illness for days before exposure is quarantined.

Similarly, the economic consequences of the virus are also lagged. Chinese suppliers are situated at the upstream end of many global supply chains. Many of these suppliers have severely curtailed operations in order to prevent local contagion to the virus. Reports are now surfacing that many container ships moving Chinese-produced goods are either a) sailing from ports with loads far below capacity or b) not leaving port at all.

Because it takes at least a month for many upstream shipments from China to make their way to downstream US retailers, the material consequences of these disruptions won't be visible for several weeks here in the states. Meanwhile, the time lags involved add uncertainty that make ultimate outcomes more difficult to forecast.

I wonder whether market discounting mechanisms that have been mucked up with so much easy money will be able to cut thru the fog of uncertainty and accurately foresee the lagged effects in this case.

Low Banks

Have to catch an early train
Got to be to work by nine
And if I had an aeroplane
I still couldn't make it on time
--The Bangles

We've noted the low relative valuations of the energy complex against broader markets several times recently (e.g., here, here). Hadn't realized that bank stocks have also been touching long term relative lows vs the major indexes.

Ratio of Bank stocks to the S&P 500 hitting a new low today, below the March 2009 low. $KBE $SPY pic.twitter.com/03FRT8LHSz

— Charlie Bilello (@charliebilello) February 14, 2020

Bank stocks are breaking below levels set at the March 2009 bottom.

Uncertainty and Real Options

Can you see the real me?
Can you? Can you?
--The Who

Investment is the act of incurring immediate cost in expectation of future rewards. Investment decisions generally share three characteristics (Dixit & Pindyck, 1994). First, the investment is irreversible to some degree. Should you change your mind and want to unwind the investment, its initial cost cannot be completely recovered. It is at least partially sunk.

Second, the future rewards associated with the investment are uncertain. Alternative outcomes associated with higher or lower rewards might be identifiable, but the best you can do ex ante is estimate probabilities of those various alternatives to guide your decision.

Finally, latitude exists about when the decision can be made. You can postpone action to get more information in order to reduce--although never completely eliminate--uncertainty about the future.

The possibility of delaying an irreversible investment decision creates an option--i.e., the right, but not the obligation--to buy an asset at some future time. Analogous with options in financial assets, opportunities to acquire real assets under such flexible arrangements are sometimes called 'real options.'

Reference

Dixit, A.K. & Pindyck, R.S. (1994). Investment under uncertainty. Princeton, NJ: Princeton University Press.

Steeped in Aggression

All in all
It's just another brick in the wall
--Pink Floyd

Some claim that the current ESG movement, where investment decisions are being made according to the environmental, sustainability, and governance profiles of target corporations, is 'market driven.' After all, fund managers are allocating capital out of their own volition driven by their own ideals.

However, these ideals have not been formed freely. They flow from particular political ideologies. Government has funded programs that promote, for example, global warming and climate change, and public schools been indoctrinating young minds to these notions for years.

Because resources to fund these initiatives have been sourced from taxpayers, the ESG movement can be seen as an outcome stemming from another in a long line of government-sponsored propaganda campaigns. Rather than being peacefully driven, it is a movement steeped in aggression.

Dotcom Deja Vu

"The guy's a computer wiz. Started up a dotcom out of Virginia called Dollar.com. 'Anything you want under a dollar.' And he did great. Lucky bastard cashed out just before the bubble burst."
--Henry Wayne (Exit Wounds)

Tech valuations vs energy and industrials are pushing tech bubble proportions.

Tech’s dominance relative to energy & industrials@FT @Refinitiv pic.twitter.com/fiwQktCvlW

— Liz Ann Sonders (@LizAnnSonders) February 14, 2020

Feeling some dotcom deja vu.

Grand Old Flag

"If this man should fall, who will lift the flag?"
--Col Robert Gould Shaw (Glory)

Bullish flag pattern forming in Pan American Silver (PAAS). Technical doctrine says flags usually resolve in the direction of the dominant trend.

Pattern could also be seen as tracing the handle on a 'cup-and-handle' pattern.

Either way, action appears strong.

position in PAAS

Non-Housing Debt

"If he makes anybody rich, let him make himself rich...so he can pay off his school loans."
--Carl Fox (Wall Street)

Consumers have been taking on more non-housing debt over the past decade. It now comprises about 30% of household debt (mortgage-related debt comprises the remaining majority).

While car loan debt burden has been on the rise, student loans are the primary contributor to the increase. Their share of consumer debt has more than tripled since 2003.

Credit card debt, on the other hand, as declined slightly as a fraction of total consumer debt.

Liquidity Engine

Who's gonna tell you when 
It's too late?
Who's gonna tell you things
Aren't so great?
--The Cars

Fed liquidity index courtesy of CrossBorder Capital suggests that domestic liquidity stemming from central bank monetary policy is at series highs.

12m change in Fed liquidity suggests this might be largest boost in over 50 years @federalreserve @crossbordercap @SoberLook pic.twitter.com/Cve9027yiU

— Liz Ann Sonders (@LizAnnSonders) February 11, 2020

This is the engine powering stock markets higher.

Seeing the Bullish Case

"I can see why you believe that you have nothing left here."
--Guinevere (King Arthur)

It should be no revelation that market commentary on these pages tilts toward a bearish slant. And, to be sure, there are plenty of reasons to believe that security prices, particularly stock prices, are due for a fall--perhaps a big one.

However, even if one has a pessimistic outlook on financial and economic conditions, there are some plausible reasons for stocks to levitate higher. I have been pondering two in particular.

One is the income producing character of equities. With interest rates once again approaching the 'zero bound,' dividend paying stocks appear attractive--particularly to retirees and others looking for income supplements or replacements. Despite the run-up in stock prices, a solid portfolio of stalwart companies with safe dividend profiles can be assembled with a yield of 3% or more. For those willing to stomach up and downs in account value in return for steady income well above that provided by most fixed income instruments, this arrangement appeals to a large group of investors. As long as rates remain unusually low, equity prices--particularly those of dividend payers--may remain well bid.

A second reason for stock prices to remain elevated is the prospect of Big Inflation. In other countries where inflation has really picked up, stocks usually move higher--albeit in devalued currency. While they may not be able to keep up quite as well as alternative assets such as gold, equities are likely to outperform cash by a substantial margin in the event that inflation really takes off.

For aging baby boomers and others trying to create investment income while hedging against inflation, stocks look like an attractive asset class at this point in time.

position in gold

Interest Rate Decline

It's been such a long time
I think I should be going
And time doesn't wait for me
It keeps on rolling
--Boston

Interesting graph of interest rates over many centuries courtesy of Visual Capitalist. Obviously, the trend over the past eight centuries has been down.

Several theories are proposed to explain long term interest rate decline. Productivity growth should influence interest rates. As productivity increases, scarcity declines. More capital should be available to borrow, thereby lowering borrowing costs.

The article takes a different view, however. Focusing on the continued decline in rates over the past 30-40 yrs, the author proposes that lower productivity leads to less business investment and therefore less demand for capital. The opposite should be true. Lower productivity means that capital will be more scarce. Less supply means higher prices, all things equal.

The author also proposes aging demographics and slowing economic growth as driving rates lower recently. Of course, this does little to explain the longer term down trend, as there were many periods over the past few centuries where populations grew dramatically and economies boomed.

It is also noted that bond yields have been falling coincident with declining rates--as if bond yields are supposed to trend independent of interest rates. Let's clear up the confusion. Interest rates constitute a price--the price associated with borrowing money. Bonds are a vehicle for borrowing money. Bond 'yield' coincides with the borrowing price. The real news would be if interest rates and bond yields were not highly correlated.

What the article completely ignores is the work of central banks over the past 100+ years to interfere with the natural rate of interest. Slowdown in productivity growth should have caused rates to level out or perhaps to rise. However, central bank intervention has continued to force rates lower, thereby keeping the eight century downtrend in place.

If central banks lose control of rates, then they will surely rise and jeopardize the long term downtrend.

Tech Ten Bagger

"One thing I don't understand is high tech."
--Sandy Riggs (In the Line of Fire)

The NASDAQ Composite (COMP) is now a ten bagger off the March 2009 lows.

The Nasdaq 100 is now a ten-bagger since its low in March 2009. +900% $QQQ pic.twitter.com/rKRGu4gFMU

— Charlie Bilello (@charliebilello) February 6, 2020

An eye catching move for individual names, but for an index...

Implied Volatility and Policy Uncertainty

Okay
Just a little pinprick
There'll be no more aaahhh
But you may feel a little sick
--Pink Floyd

Chart shows relationship between VIX and Baker et al's Policy Uncertainty Index over time.

The VIX is a measure of 'implied volatility' which can be viewed as a proxy for market-related uncertainty.

A widening gap is evident--one that began around 2000.

One possible interpretation: increasingly aggressive monetary policy is making investors comfortably numb to uncertainty happening in the larger world.

Asset Price Inflation

I'll buy you a diamond ring my friend
If it makes you feel alright
I'll get you anything my friend
If it makes you feel alright
--The Beatles

Building on yesterday's observation, Liz Sonders observes that there has been inflation over the past decade--in asset prices rather than in goods/services prices.

Not a lot of real economy inflation over past decade; but plenty of asset inflation pic.twitter.com/GK0t0IdJoa

— Liz Ann Sonders (@LizAnnSonders) February 6, 2020

As Cantillon first observed nearly 300 yrs ago, prices tend to increase most in the vicinity of where new money is created.

Inflation Expectations

"Maybe now would be a good time to go over what you expect of me."
--Alice Baxter (Working Girl)

Liz Sonders Fed 'easy money' policies have jacked markets but haven't raised inflation expectations. But why should money created primarily for use inside the financial system influence public expectations for higher prices of goods and services?

Fed’s 2019 rate cuts & liquidity injections helped lift stock prices, but haven’t done same for inflation expectations pic.twitter.com/myJX6lnf8J

— Liz Ann Sonders (@LizAnnSonders) February 5, 2020

Obviously, the Fed's accommodative policies have elevated expectations of higher prices of stocks, bonds, et al among financial professionals. After all, they are the first users of the newly minted cash.

Want to elevate expectations of higher prices among the general public? Then start dropping money from helicopters. As it lands in the streets, watch inflation expectations--and general prices--take off.

Tesla Mania

She's so high 
High above me
She's so lovely
--Tal Bachman

Markets are currently obsessed with everything ESG (environmental-sustainability-governance). Fund managers proclaim that they will only own shares of companies with positive ESG profiles. That means buying everything green and selling everything black (as in crude).

Nothing exemplifies this mania more than Tesla (TSLA). The stock has quadrupled in the last 8 months and now sports a market cap (~$140B) greater than any car company save for Toyota--despite its tiny production levels.

The parabolic frolic is unmistakable and reminiscent of bubbles past. The stock, btw, is indicated another $100 higher pre-market this am.

no positions

Place To Be

When situations never change
Tomorrow looks unsure
Don't leave your destiny to change
What are you waiting for?
--Swing Out Sister

Graph below shows that US equity markets have been the place to be over the past decade.

What will the coming decade bring?

Four Trillion$

I keep a close watch on this heart of mine
I keep my eyes wide open all of the time
I keep the ends out for the tie that binds
Because you're mine, I walk the line
--Johnny Cash

With Amazon's (AMZN) pop on positive earning last week, we briefly added a fourth stock to those sporting market caps of at least $1 trillion. The melt on Friday took both AMZN and GOOG back below the line.

For the first time ever, there are 4 trillion-dollar companies in the US: Apple, Microsoft, Google, and Amazon.$AAPL $MSFT $GOOGL $AMZN pic.twitter.com/e7FPXJVvFN

— Charlie Bilello (@charliebilello) January 30, 2020

Here's the current standings:

AAPL $1.35T
MSFT $1.29T
AMZN $996B
GOOG $988B

Who's next in line, you ask? Facebook (FB) currently ranks #5, but at a mkt cap of $576 billion it's gonna need a big rally to cross the line.

no positions

Brexit Now

London calling to the imitation zone
Forget it brother
You can go it alone
--The Clash

I second Rand Paul's best wishes to the UK as Brexit is done.

I wish the United Kingdom all the best as it gains back sovereignty, independence and liberty! I very much look forward to working with you to strengthen our ties for the benefit of all our people! 🇺🇸 🇬🇧 @Nigel_Farage @BorisJohnson @DominicRaab https://t.co/NKOrho4dbR

— Senator Rand Paul (@RandPaul) February 1, 2020

Countries walking away from treaties does not imply some sort of xenophobic nationalism. It reflects natural impulse for sovereignty and self-determination.

It does not mean isolation. Prosperity is built thru specialization and trade rather than from self-sufficiency. Co-dependence not thru force, but thru voluntary cooperation between sovereign entities.

With Brexit, the UK is choosing freedom over force by being open for business.

Cyclical or Secular?

Then one day he was shooting' at some food
And up through the ground come a bubblin' crude
Oil that is
Black gold, Texas tea
--Flatt and Scruggs

Chart shows that, over the past 8 yrs, Exxon Mobil (XOM) stock has lost money while the SPX is up nearly 2x. I doubt whether this chart truly indicates 'total return' basis, however. My charting program suggests XOM's share price down ~6% but the stock's hefty dividend closes the gap somewhat.

That said, XOM's (and the entire energy sector's) under performance is undeniable. The question is whether this under performance is cyclical or secular.

I'm betting the former.

position in XOM