Wednesday, June 3, 2020

This Week's Message: Not So "Classic" After All

While market history and a veritable plethora of data allow me to continue my this-is-a-classic-bear-market-rally (BMR) narrative, the fact of the matter is that we're at the point where I need to dispense with the word "classic".

This one -- "one" implying that I still see this as a BMR -- has taken its "retracement" beyond the historic norm (relative to the "classic" bear markets I've previously illustrated herein).

Note that the S&P 500 has now retraced over 75% of the Feb/Mar selloff:  

click to enlarge...

Versus the initial retracement rally of 2008, which made it roughly 60% of the way back,

the initial tech bubble retracement of just over 50%,

and the initial 1929 Great Depression initial retracement of just under 60%:

Now of course there are multiple more bear markets and corrections we can illustrate, double and triple tops (prices coming all the way back only to fall apart in deeper fashion), etc.

Here are two examples of retracements (since the 2009 bottom) that turned out to be greater than the current one before plumbing lower lows. Both finding long-term bottoms just shy of bear market land, which obviously omits them from my "classic bear market" list:

While we'll continue to share herein the macro trends and market data that inform our actions as we meander through these unique times, for this week's message I want to simply acknowledge the fact that while market history, as illustrated in the charts, divulges patterns that, particularly at the extremestend to repeat, there are simply no guarantees. 

I.e., I can crunch, calculate and chart till my fingers turn blue, but, at the end of the day, absolutely, it could be different this time.

It absolutely could be that policymakers will succeed in printing and lending sufficient buoyancy into the stock market to keep it afloat till the economy comes all the way back to its early '18 trajectory (before it began slowly rolling over). In which case the best we'll be able to illustrate is that huge positive gap between our hedged portfolios' results and the market's at the March 2020 lows. I.e., our strategy successfully removed all risk of devastation, but the conditions that would've had us rotate to growthy mode near a market bottom (a la 2009) never materialized. 

In the above scenario, growthy conditions will materialize at, ironically, a higher level (price and valuation-wise) for stock prices for the first time ever. As unlikely as that may sound, clearly, that's what's being presently priced in. The question is, who's doing the pricing? Well, if, as some suspect, it's Robin Hoodies, performance-chasing algos and panicky short-coverers, we're, frankly, still very deep in the woods...

In any event, the conditions that would have us discontinue our hedging and rotating to growthy mode are simply non-existent at this juncture. That said, our full core allocation (with its 23% cash, and overall defensive sector/asset class posture) -- which applies to portfolios above $250k (and those void of legacy assets held for tax purposes) -- has captured 76% of the MSCI World Index's move over the past week, and 90% of the S&P 500's. 

Now, don't take that last sentence and run with it; our current core allocation is not nearly as correlated to stocks as it was even a year ago. I.e., we'll continue to see the occasional daily counter-market move as long as we remain in this mode. And, yes, our 100% core, hedged, allocation continues to outperform the major averages (save for the Nasdaq) on a year to date basis...

As for the ultimate consequences of what has become a level of intervention into markets that is tantamount to the polar opposite of capitalism (I'll leave you to come up with the correct term), here's from former New York Fed President Bill Dudley, of all people, in a Bloomberg interview this morning. This should sound very familiar to regular readers:
"Federal Reserve action to keep credit flowing rewards risky behavior and the remedy may be tougher regulation in the future"
“People who have high-yield debt that’s outstanding, a lot of times that’s happened by choice”

“So for the Federal Reserve to intervene and support those asset prices, is basically creating a little bit of moral hazard in the sense you’re encouraging people to take on more debt.”

“We had a number of players in these last few months that have essentially been bailed out by the Fed"
"Fed Treasury purchases helped “those entities unwind what turned out to be a bad trade.”
“If people become very leveraged and they’re big enough to be systemic, then I think there needs to be some regulation to reel that in,”

“It’s one thing if you have a financial crisis every 50, 100 years. If you start to have a financial crisis every 10 years, then the Fed’s actions are going to encourage people to
take more risk in the future.”
Again, if indeed the Fed "succeeds" in keeping asset prices afloat through modern history's worst recession, the risky credit conditions that would've suggested otherwise will be substantially greater than they were coming in. Try and get your head around that one!

Thanks for reading!

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