I’ve updated my Keeping Score page to reflect S&P 500 results for March and 1Q20. Especially bad news for Energy and Financials.
talking directly with customers
Before the financial crisis, equity portfolio managers rarely talked directly with retail customers. The central marketing concept was to create “third-party endorsements” by appearing on financial television programs. Oddly, in my view, but I’m confident it’s correct, retail clients were more powerfully convinced to invest by a portfolio manager’s appearance on CNBC than by a fundamentally sound approach, a strong analytic staff and a long record of outperformance,
That strategy no longer works. I’m not sure about the dynamics, but in today’s world the talking heads fancy themselves to be the real experts, even though few if any have ever been professional investors and they all by and large spout nonsense as far as I can see–entertaining nonsense, but still nonsense.
What I find interesting about the current market decline is that I’m seeing mutual fund and ETF providers conducting online presentations/client meetings with their fund holders. I think this makes a lot of sense. It may turn out to be one of the (many, I think) fundamental business changes that occur as a result of our current unusual circumstances.
reading stock prices
When I started my second job as a portfolio manager, Australia was the area I was responsible for. Every morning my boss would call me into her office and grill me about the course of the market overnight. She would say a ticker symbol. I had to tell her the high/low/close; the volume if it was unusual; the brokers (and clients, if possible) most involved; and whether or not the movement was in line with other names in the relevant industry or not. If not, why not.
It was pretty awful. And the practice lasted until I knew more than she did about what was going on. But I learned a valuable lesson–that many times the prices talk.
The US market is big enough that no one can listen to all the prices. But I think there are times when the prices are unusually informative. This is one of them, in my view. What I see is that the market is trying to separate post-pandemic winners from losers. My read is that weak stocks now are expressing the market’s first pass at what will continue to be weak from here on.
market cliché of the day
The cliché: when the market recovers from a serious decline, the old leadership is left by the wayside and new leadership emerges.
The “old” leadership is multinational firms without extensive manufacturing located in the US, tech and especially software, in particular.
Will this happen now? My guess is no.
That’s the way it usually works. The market bottoms the first time (the consensus seems to be forming that that’s what’s happening now) at the time of the utmost bad news. It then rises for six weeks or so …before returning to “confirm” the bottom by touching the former low, or maybe a tad lower, before motoring ahead for good.
I’ve written about this process now and again, including just recently. But I’ve heard and read predictions of a double bottom–“don’t buy now, wait for the second bottom”–that I’m beginning to think that won’t happen this time. I have no idea, though, what might take its place.
I thought three items were interesting:
Hotel occupancy in New York City is currently at 20%. How low is that?
–at 70% occupancy, hotels make tons of money
–at 60%, they’re at breakeven on a financial reporting basis
–at 50%, they’re at breakeven on a cash basis. Normally this is where they are this time of year
–at 30%, they give off an eerie “empty” vibe and people are nervous about staying
Population growth in the US during the year ending July 2019, at +0.48%, was the lowest in the past century.
The recent trend had been for a population increase of about 1.5% annually, composed of equal parts new births and immigration. The birth rate has fallen off since the financial meltdown in 2008, however. Also, the current administration is suppressing immigration, both at the borders and through a white racist tone that makes foreigners (at least my friends) fear to come/remain here.
This makes a difference because in its simplest formulation GDP expands either by having more people working or having workers become more efficient. The poster child for the consequences of an anti-immigration stance combined with an aging population is Japan, which hasn’t shown much growth for the past thirty years.
If we assume that we can achieve steady 1% annual productivity growth (a lot), the ceiling for GDP growth in the US is around +1.5% a year.
Immigration suppression is one of the key ways the current administration is creating not-yet-fully-felt, long-term damage to the domestic economy. Not felt, but not unseen on Wall Street, I think. This and the tariff wars are the main reasons the US-centric Russell 2000 has lagged the other market indices by so much over the past two years.
Despite its media ubiquity and the fact it has survived all these years, the DJI is a weird index:
–it contains only 30 names out of the thousands of publicly traded companies
–although the index owners have tried to make it more relevant in recent years by adding Apple, Microsoft and Nike, it still by and large represents the big-cap names of America’s yesterday
–the weighting of a given name is a function of its per share stock price, not the size of the company. As a result, Microsoft counts less than Visa, despite being 3x V’s size. MSFT is about 1200% the size of IBM, but has only a third more weight (stock price of 150 vs 110). While the ease of calculation this brings might have been important in the pre-computer age, it’s an anachronism now
–because of all this, using the DJI is a convenient signal to the listener that a speaker knows very little about stocks. Odd that it should be used by media stock “experts” …or maybe not.
Pre-APPL, MSFT, NKE, the DJI did have one important use. When it started to outperform, that meant that a rally was near its end (and portfolio managers were buying the least interesting, but cheapest stocks) or that pms were seeking the safety of large, mature companies. The additions above have lessened that appeal.
However, in the current climate, the DJI is an interesting collection of coronavirus losers.
Year-to-date, as of the close on Monday, the Dow was down by 35%, the S&P 500 by 30%, NASDAQ by 24%. Since then, the DJI has been by far the best performer. Interestingly, the Russell 2000, which measures mid-cap US, was down by 40% on Monday and has bounced by about 8% since, tying it with the NASDAQ for smallest bounce.
Two days isn’t much to go on, but one read is the market thinks the bailout will mostly benefit the large old-guard industrials. A caveat: the 57% rise in Boeing over the past two days accounts for two percentage points of the DJI rise.
In the middle of a garden-variety bear market–i.e., one orchestrated by the Fed to stop the economy from running too hot–I remember a prominent strategist saying she thought the market had fallen far enough to be already discounting the slowdown in profits but that the signs of recovery were yet to be seen. So, she said, we were in a bear market in time.
We’re in a different situation today, though:
–most importantly, we don’t know for sure how much damage the coronavirus will do, only that it’s bad and we unfortunately have someone of frightening incompetence at the helm (think: the Knicks on steroids) who continues to make the situation worse (while claiming we’re in the playoffs)
–with most of the seasoned investment professionals fired in the aftermath of the financial crisis, and replaced by AI and talking heads, it’s hard to gauge what’s driving day-to-day market moves
–if we assume that the US economy is 70% consumption and that this drops by 20% in the June quarter, then COVID-19 will reduce GDP by 14% for those three months. This is a far steeper and deeper drop than most of us have ever seen before
–on the other hand, I think it’s reasonable to guess that the worst of the pandemic will be behind us by mid-year and that people released from quarantine will go back to living the same lives they did before they locked themselves up.
It seems to me, the key question for us as investors is how to navigate the next three months. In a pre-2008 market what would happen would be that in, say, six or eight weeks, companies would be seeing the first signs that the worst was past. That might come with more foot traffic in stores or the hectic pace of online orders for basic necessities beginning to slow.
Astute analysts would detect these little signs, write reports and savvy portfolio managers reading them would begin to become more aggressive in their portfolio composition and in the prices they were willing to pay for stocks.
How the market will play out in today’s world is an open question. AI seem to act much more dramatically and erratically than humans, but to wait for newsfeeds for stop/go signals. (My guess is that the bottom for the market ends up lower than history would predict and comes closer to June. At the same time as the market starts to rise again, it will rotate toward the sectors that have been hurt the worst. Am I willing to act on this? –on the first part, no; on the second part, looking at hotels, restaurants…when the time comes, yes)
A wild card: Mr. Trump now seems to be indicating he will end quarantine earlier than medical experts say is safe. At the very least, this will likely bring him into conflict with the governors of states, like NY, NJ and CA, who have been leading efforts to fight the pandemic. At the worst, it will prolong and intensify the virus effects in areas that follow his direction. Scary.
I submitted a rough cut of my video to SVA last Wednesday and have been whittling down the huge pile of unread Financial Times newspapers in my kitchen.
An aside: I get the digital FT, too. But if for an investor the idea is to find out stuff other people don’t know yet, then what you should look for are the short articles on the back pages of the paper–not curation by what’s trending.
Two items stand out to me so far; VIX readings and mutual fund/ETF redemptions.
The VIX is an index that tries to measure fear and greed in the stock market by, in my crayon-like understanding, calculating how much the price of puts on S&P 500 stocks exceeds theoretical value (using something like Black-Scholes, something borrowed from the physics of Brownian motion) and dividing that number by the amount that calls exceed their theoretical value. The methodology was changed somewhat in 2003(?) and I can’t find a clear description of the new one.
People use the VIX as a gauge of market fear, on the idea that when investors are scared the premium on puts goes up and/or the premium on calls goes down. The all-time high for the VIX was around 150, posted 4x during the stock market decline of late 1987 (these are new VIX numbers, not those actually posted, which are much lower). The figures we’re putting up now are the next highest.
In really bad times since then, the VIX has surged above the 40 line. Last Wednesday it cracked through 80. There are legitimate questions as to whether the VIX is really the Fear Gauge it is presented as being on stock market programs. Whatever the case, it indicates market turmoil.
For us as investors, the VIX is important, on the idea that maximum panic by sellers indicates a turning point in the market. How so? Sellers either run out of stuff to liquidate or they faint at their desks. Either way, selling stops.
There has been a general drift over at least the last decade in the mutual fund/ETF business away from equity funds and into bond funds. Over the past three weeks or so, however, there has been a huge surge in bond fund redemptions. According to the FT, for the week ending last Wednesday, investors yanked $109 billion from fixed income funds (a record high), compared with $20 billion taken out of equity products. A fraction of the money is finding its way into money market funds. As for the rest, bank accounts?
Again, redemptions of stock mutual funds/ETFs are generally another decent fear gauge. Bond redemptions are unusual, though, since, in theory at least, as the Baby Boom ages it gravitates more and more to bonds.
Two factors cut against this idea in the present case. The yield on the stock market is way higher than the yield on bonds. Maybe more important is the fear, justified or not, that the coronavirus will force fixed-income issuers to default on their obligations.
feeling for the bottom
panic in the air
During bad markets like the present, company fundamentals tend to go out the window as predictors of short-term stock market performance. What takes their place is varying shades of fear and reading charts.
As for fear, I’ve found in watching my own usually-optimistic behavior, that no matter how far down the market has fallen it isn’t approaching a bottom until I start to get scared–that maybe my innate cheeriness has finally ruined my career and the family finances. For what it’s worth, I started getting these (irrational) feelings for the first time on Wednesday. It could be that my last-minute rush to get my thesis project finished and submitted to SVA contributed a feeling of panic. If not, my Wednesday experience is good news.
My version of William Pitt is to say that charts (not patriotism) are the last refuge of scoundrels. Nevertheless, when rationality flies out the door, charts are what’s left.
In the US, despite the chatter of TV actors, the important index is not the Dow but the S&P 500. The important things to look for, in my view, are past bottoms and places where the index has been flattish for an extended period of time. That’s not a lot to go on but that’s most of what there is.
In this case, the relevant figures I see are 2400, which was the bottom for the mysterious market drop at the end of 2018 and 2100, where the S&P spent much of 2015-16.
Two idiosyncracies of the US market:
–the index often breaks below a big support level–scaring the wits out of traders who see themselves sliding into a yawning abyss, in my view–before reversing itself. The break below signals the bottom
–almost always the index recovers for several weeks before returning to, and bouncing up from, the initial bottom. This didn’t happen in 2018, though.
My guess is that the worst of the coronavirus will be behind the US by June. If that’s correct, then at some time in May (?) the stock market will begin to discount better times.
The biggest economic negative has come from the White House, where the incompetence of Mr. Trump was on full display, raising echoes of the disaster he created in Puerto Rico earlier in his term. Not far behind is the recent revelation that Republican senators dumped their stock portfolios after coronavirus briefings, while still toeing the party line that there was nothing to worry about. (My view is that Trump has done an enormous amount of long-term economic damage to the US in his presidency so far–hurting most deeply those who have trusted and supported him–but that we have yet to see the negative consequences.) Somehow, Washington appears to have started to function again, however.
On the other hand, state and local officials have negated some of Trump’s “hoax” campaign by acting quickly and decisively.
From a purely stock market view, it seems to me that investors have switched out of panic mode and are beginning to sift through the rubble to sort winners from losers. If I’m correct, it’s important for us as investors to pay attention to what the market is saying now–and ask ourselves how well this matches with our sense of what is happening.