Macro Update: And A Fundamentally-Sound Theme To Exploit...

Just finished our weekly formal macro exercise, and for the 9th consecutive week our overall assessment has not deteriorated. I.e., things improved during 6 of the weeks off of the June-1st bottom, stayed flat during 3.

Morning Note: Not feeling the love...

Asian equities were mixed overnight, with 10 of the 16 indices we track trading lower. Two of the gainers represent Chinese stocks, and that reflected better than expected economic data. As you know, in a controlled economy you can, well, control many things. You can literally order your factories to produce stuff even when their international customer base isn't in nearly the buying mood to justify it. Voila! Growth! But what a potential mess later on as those inventories pile up... 

Evening Note: At Best...

I've noticed a developing trend in my end-of-day perusing of credit market internals; it's that most things credit appear to be truly on the mend.

To give you a visual, below is a color-coded handful of the things we track. While this clearly isn't screaming green, rest assured that it's a far tamer look than we were getting just a few weeks ago.

• CREDIT

• BIZD: ETF TRACKS INDEX OF BUSINESS DEVELOPMENT COMPANIES (BUYERS OF THE WORST CREDITS): Ytd: -30.4%, retraced <50% of BM decline...

• LEVERAGED LOAN PRICE INDEX: Ytd: -5.3%, retraced >62% of BM decline…

• PSP (Private Equity ETF): Ytd: -15.80%, retraced >62% of BM decline.

• HYG: Ytd: -308 bps, retraced >76% of BM decline…

• MUNI/TREASURY SPREAD: 122% of 10-yr treas, 61% wider vs equity mkt peak

• HY SPREAD (1-day behind): 489 bps, 36% wider vs equity mkt peak

• Ba SPREAD: 342 bps, 60% wider vs equity mkt peak

• BB-BBB SPREAD: 168 bps, 95% wider vs equity mkt peak

• CDS Inv Grade Index 70.37

• PWA FIN’L STRESS INDEX -12.5

So what gives? I mean, just last evening I illustrated how corporate debt stress -- in terms of debt service relative to key corporate income metrics -- is rising in a manner never seen in the history of all past recessions. Not to mention Q2 GDP declining at an all-time record quarterly pace, and the 1.4 million in first-time unemployment claims filed last week. How on Earth could credit markets be so sanguine right here?

Well, if you listened to Fed Chair J. Powell talk up US monetary policy yesterday, you'd understand completely. Essentially, while he was as straightforward as a fed chair could be in terms of the anything-but-rosy present state of affairs, his commitment to keeping markets afloat was firm, unwavering and unlimited in scope. 

The thing is, however, if the current episode is indeed to fall short of ending in what we'll call massive blood in the financial streets, we have to ultimately be concerned with what we end up with on the other side? For if the authors of The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis have it right, central banks at best are merely what they call "agents of carry", and, thus, can at best only succeed in keeping this massive corporate debt bubble inflated. Well, till they can't...      

emphasis mine...

The wealth that is made by the financial players (and businesses and individuals) who are implementing carry trades is not real wealth of the sort that derives from an economy’s greater ability to produce better goods and services that the general population needs and desires. On the contrary, it causes financial asset prices to become hopelessly distorted, unhinged from the real economy, and therefore ends up misdirecting scarce capital into potentially unproductive uses. Over time, the economy will perform progressively more poorly, with income and wealth more and more concentrated in a few hands.

Nevertheless, it is also important to realize that the carry regime, as it progresses, fundamentally weakens the true power of central banks (and by extension governments). This may seem counterintuitive, but as with regulatory capture, central banks are themselves “captured” by carry. During the intensely deflationary carry crashes (such as occurred in 2008), they appear to have no option other than to increase moral hazard further, via even greater intervention and bailouts. In one of the various seemingly contradictory aspects of the carry regime, central bankers seem to have enormous power—their extraordinary power to create high-powered money, set short-term interest rates, and strongly influence financial markets with everything they say—but ultimately they themselves have little latitude to act. Central banks become merely the agents of carry. Their seeming immense power is, in reality, mostly illusory.

If you're unfamiliar with the term "carry trade", it typically refers to the act of borrowing in a low-yielding currency and lending in a higher yielding currency, the differential (the profit) is called "the carry." The authors quoted above use the term to describe any scheme that involves "the use of borrowed funds or else utilize some set of contracts that creates a potential risk of loss greater than the amount of capital initially employed in the trade." Which, alas, describes the myriad of "trades" investors, pension funds, other institutions, etc., have resorted to either out of greed, or need, these years since the last bubble burst. These include everything from currency carry as described above, writing insurance, selling credit default swaps, buying high-yielding equities or junk debt on margin, mortgaging property investments, writing options, and buying leveraged ETFs, to companies borrowing to fund share buybacks, to a whole gamut of other complex financial strategies.

I.e., Suffice to say that the Fed has its back against a ginormous wall of risky debt-financed schemes that allow for very little volatility in financials markets; without, that is, major systemic consequences...

Stay tuned, and stay hedged...

Thanks for reading,

Marty 

Morning Note: Morning Note: All Juiced Up

Asian equities, having closed before the firework show in the West got underway, actually saw a little green overnight, with 6 of the 16 markets we track trading higher. Europe, on the other hand, being wide awake this morning is seeing nothing but red, with all of the 19 bourses on our radar down, by a bunch. Same for the U.S., with the Dow down 520 points (-2%), the S&P 500 off 1.5%, the Nasdaq lower by 1.1% and the Russell 2000 down 1.7%.

The VIX (SP500 volatility) is screaming higher of course this morning, +13% to 27.31, VXN (Nasdaq volatility) is up 7%, at 32.26.

Oil's down huge, 4%, gold's off $10, silver's getting hammered, down 3.9%, copper's off 1% and the ag complex is split roughly down the middle.

As you'd expect, the 10-year treasury yield is falling this morning (price rising), while the dollar's flat.

Our core portfolio is feeling the pain as well this morning, down 1.3% as I type. The only core component trading higher is DBA (ag commodities), and that's only by .2%. Of course the put hedges are working nicely, at the moment up 22%.

There's just no sugar-coating this morning's data; the first Q2 GDP reading is like nothing we've seen since the 1940s, down 32.9% annualized. Jobless claims increased for the second week in a row to 1.43 million, while 17 million folks filed for ongoing benefits, up 867 from the prior week.

Sure, stocks are trading lower this morning, but when you match up current levels and macro reality, well, stocks -- historically-speaking -- appear to be punching way above their weight. Good thing, at least for the moment (at least for short-term traders), that there's no steroid (Fed injections, etc.) testing in this particular contest. Of course the natural market athlete (you and me) fears the longer-term side effects of entering the ring all juiced up, while, not to mention, wearing no headgear. 

This Week's Message: Some of this month's most pertinent messaging...

Well, being that this is the last weekly message of July, I'm thinking I'll take it easy on m'self and offer up a handful of 

snippets from some of this month's messaging herein:

From "Flation is a Virtual Certainty" on July 1:

"...without question, you want to own things that are priced in dollars!

Now, of course U.S. stocks are priced in dollars, right? Right! And, sure, own some (we do), but be careful doing so when they're priced at 1999ish valuations (by several metrics) and the economy has the proverbial Mount Everest yet to climb.

And definitely own other things priced in dollars that aren't historically expensive."

"Our commodities exposure (DBA and DBB being brand new positions) now makes up roughly 20% of our core portfolio; and I suspect we'll be incrementally adding as things progress."

Here's a look at how our commodities positions stack up with stocks since I penned the above:

Click to enlarge...

 

From "Systems Thinking" on July 2:

"You're about to experience, at least at the open, what I'll call a classic what-others-think-others-are-going-to-do rally.

The linked phrase above was the subtitle to my April 10 post; I recommend you read it (again?) when you have a chance. Here's a snippet:

"My base case that stocks have yet to see the worst is entirely based on data and experience. My illustrating aplenty herein that bear market retracement rallies are the norm is meant to help our readers understand how incredibly risky it is to wade into this snap-back rally as if the bear market is already over. Which, by the way, would make it the shortest on record -- amid the worst economy on modern record! Just seems like a very far-fetched notion if you ask me..."Still my base case, by the way...

In a nutshell -- in the short-run:

"Keynes suggested circa a century ago that trading (as opposed to, I'll say, investing in) markets is not about assessing fundamentals, it's about what traders think other traders are going to do. And for the more savvy traders, it's about what they think other traders think other traders are going to do.""

From "A Better Look, Commodities, and A Monster Mountain Left to Climb" on July 3:

"The next few weeks will be telling, as, per the latest news, a number of states are delaying, and or, reversing certain stages/aspects of their reopening plans.
Half of this week's improvement showed up in the commodity space. Which, coincidentally, is something we anticipated and, therefore, have begun to express in client portfolios.

I should tell you, however, that while rising commodity prices does show up as a positive in our macro index, our bullishness there has everything to do with the prospects for a weaker dollar going forward (and, ultimately, with regard to metals, the prospects for infrastructure spending), as opposed to the prospects for robust economic growth anytime soon."

From "Beware, Reattachment Can Be Painful" on July 6:

"...in a world where the world's governments are willing to weaponize their equity markets against their respective economic woes, not to mention against each other, stock prices can remain detached from economic reality for what can seem like a very long time. History (those charts I alluded to), however, strongly suggests that the reattachment can be most painful..."

From "The Most Bullish Chart for Stocks Right Now" on July 6:

"Now this one guys/gals is the most bullish chart of all for stocks for the remainder of 2020. And it's really incredible. It's the TGA (treasury general account). Think of it as the treasury's piggy bank. The amount you see there amounts to well over a trillion dollars (1.6 in total) of new borrowing (a trillion being the normal entire-year's budget deficit) that essentially wasn't needed to fund the government. They literally issued this debt just to hold onto the cash. So, why? This is an historic first! Well, as you know, or should know, I struggle with conspiracy theories, but this one is so blatant I can't help it. This is Mnuchin essentially assuring that no matter what, whether Congress passes more stimulus, and/or regardless of what the Fed does, he has the firepower to juice the markets during the critical months leading into you-know-what in November.

Yes, this is huge support for stocks, you can bet on it. However, betting big on stocks given everything else going on (and there's lots) is -- despite what I just wrote -- hugely risky. Stocks can still fall in the face of rampant stimulus, I've seen it... If not over the next few months, dear Lord, just wait till we reach the point when they're forced to let up, even modestly, on the life support for stocks:"

From "Quotes of the Day" on July 15:

To add a little more to our messaging herein that the equity market is historically disconnected from economic reality these days, here's The Wall Street Journal's Nick Timiraos quoting from this week's banks' earnings calls:

WFC: “Our view of the length and severity of the economic downturn has deteriorated considerably"

JPM: "The recessionary part of this you’re going to see down the road"

Citi: "The pandemic has a grip on the economy and it doesn’t seem likely to loosen..."

And, lastly, here's from my latest musings in our internal market log: 

"The treasury will issue debt without restraint and the Fed will purchase it likewise, indefinitely.

Commodities -- gold especially -- are the most obvious trade under these circumstances. US equities stand to ultimately benefit as well, however -- and this will produce great anxiety for the Fed along the way (due to extreme global carry) -- with bouts of extreme volatility, given the unavoidable economic stagnation such a scenario creates, and the potential for huge political disruption -- regulation, taxation, etc. -- as growing income/wealth inequality continues unabated (exacerbated, in fact) going forward.

Foreign market equities, emerging markets in particular, stand to outperform the US markedly for several years to come; but -- while we anticipate adding there incrementally in the near-term -- we're going to let the COVID situation and the coming election play themselves out before we go there in a big way.

The immediate question for equity markets being, given the abysmal state of macro affairs, political risk, geopolitical risk and so on, will there be the 50+% correction that will reset valuations, etc., to the point I believe necessary for the US market to recapture any semblance of a “fundamentally” investable setup -- at all or anytime soon? Bottom line; that risk is there, which demands that we hedge our equity exposure against a major drawdown either until one occurs or until the risk abates…"

Thanks for reading!

Marty 

 

Chart of the Day: Anti-gravity

In client review meetings these days I find myself often proposing, then dispelling the "this time is different" notion.  

The proposition this time around is that the Fed is explicitly unfettered in what it's willing to do to "save the system."

The dispelling goes like this:

Morning Note: Traders sanguine on a potentially volatile day...

Asian equities were mixed overnight, with 7 of the 16 markets we track trading lower. Europe's mostly lower this morning, with 13 of 19 in the red thus far. While you wouldn't know it by the Dow, up only 20 points (.07%) at the moment, U.S. stocks are in rally mode to start the day: The S&P 500 is up .45%, the Nasdaq's up .65% and the Russell 2000 is up nearly 1%. Remember, the Dow only represents 30 stocks...