is there really a counter-trend rally underway?

A short while ago, I began to think that what I considered extreme performance and valuation differences between the NASDAQ index vs. the Russell 2000 (large multinational techy companies vs. medium-sized domestic firms) had become so wide that there had to be a period of catch up, when the R2000 would significantly outperform NASDAQ.

I thought it was possible that the R2000 might outperform by, say, 15-20 percentage points over a two-month period. The trigger could well be evidence emerging that the worst of the pandemic in the US was behind us. I was also noticing that I was checking my stock accounts closely almost every day–something that my experience has taught me to be a reliable sign that my holdings are getting near-term toppy.

The turn toward domestic, business cycle-sensitive names started shortly after I wrote about the possibility. BUT the move has stopped dead in its tracks this week. My reading of prices says that the market no longer wants to make this turn.

Of course, I could be wrong, as portfolio managers often are. And I’m not removing the small pro-domestic economy bet I made based on my sense that a market rotation was imminent.

What has changed?

Keeping in mind that the “what” is less important than the “that,” it seems to me that the show-stopper has been the White House. It’s the fact that new coronavirus cases in states like Florida, Texas and Oklahoma, which have relaxed social distancing precautions at Trump’s urging–and against the advice of medical authorities, are spiking sharply upward.

Trump is also launching a series of his signature political rallies, even though such events appear to be prime breeding grounds for infection. The Trump campaign has booked a 20,000 seat arena for the event, but claims to have requests for over a million tickets–which would be about half the adult population of the state, and well ahead of the number of votes Trump garnered in OK in 2016. None of this makes a lot of sense to me, nor apparently to Wall Street.

My guess is that at least until this situation sorts itself out the pro-business cycle rally is on hold.

opening back up?

The US as a nation is beginning to relax the most severe social distancing measures put in place to make sure a tidal wave of COVID-19-infected people wouldn’t overwhelm the medical care system.

I have no idea what’s going to happen as we recover, but I’m willing to hang my hat on two ideas:

–the key issue is hospital capacity, and

–that reopening will continue, with the throttle being opened or choked back, not by the number of new virus cases, which I think will likely rise, but by the availability of hospital beds.

 

The stock market senses this policy shift and is starting to react.  “Starting” may be a bad word.  The Russell 2000–mid-sized firms with revenues and costs in the US–was down by 40% ytd a month ago.  It has risen by about a third since then, meaning it’s still down by a bit more than 20% ytd.

Banks, hotels, cruise lines, restaurant chains all show similar patterns.

Just as important, secular growth, capital flight tech names, which have been very strong so far this year (MSFT is up by 10%, for example, the ARK Genomics ETF is +20%  (I own both (btw, I really like the ARK people and own several of their ETFs)), are beginning to lose steam.  (This is really a horrible sentence.)

What to do?

This is, of course, mostly an issue of investment philosophy and risk tolerance.  For what it’s worth, I’m very aggressive, have a portfolio I actively manage, where I’m very heavily weighted toward tech.  I’ve begun to shift a tiny bit toward the names that have been crushed by pandemic fears.

So far I’ve bought a Russell 2000 ETF and established a small position in Marriott (MAR).

I’ve thought about the cruise lines, which are the swing for the fences “value” bet, and decided I don’t know enough and don’t want to take the risk.   There should be (I haven’t looked) a ton of very recent information on the SEC EDGAR site about Carnival (CCL) given the company’s recent financing, which should give prospective buyers some comfort.  But at the end of the day I can imagine taking a small-boat river cruise but I’m not a CCL customer.

I also thought about Boeing (BA), but I’m not sure I have any clue about the depth of incompetence and corruption involved in the company’s newest commercial aircraft development.  My experience suggests we’ve only seen the tip of the iceberg.  The counter-argument is that BA has a substantial defense business and that it’s one of only two major aircraft manufacturers in the world.  So it can’t be allowed to fail.  I’m passing, though.

(An aside:  the key to investment success is not to have an opinion about everything;  it’s to know more than most about a few things that you monitor carefully.)

Why MAR?  A simple answer is fewer warts than CCL or BA.  I know something about the company and use its products.  Also, by and large, publicly traded hotel companies don’t own the physical hotels.  They provide branding, property management and reservation system services, in return for taking the lion’s share of profits.  Yes, less upside than with property owner CCL, but also less risk that my ignorance will come into play in a bad way.

Assuming I’m correct about this market shift, is this just a counter-trend rally?  Yes, but…  There may be a quibble about the word “just”;  but this domestic-centric rally could go on for months.

At some point it will be important to have ideas about how the post-pandemic US will be different.  I’m not sure that’s right now, though.  I think it’s better to be trying to figure out which firms will lose their appeal in a post-pandemic world–and use them as a source of funds to play the current rally.

a bear market in time? sort of…

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.

 

 

 

feeling for a bottom

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.

charts

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.

the economy

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.

 

 

 

 

dealing with market volatility

Beginning rant:  finance academics equate volatility with risk.  This has some intuitive plausibility.  Volatility is also easy to measure and you don’t have to know much about actual financial markets.  Using volatility as the principal measure of risk leads to odd conclusions, however.

For example: Portfolio A is either +/- 1% each week but is up by 8% each year; Portfolio B almost never changes and is up by 3% every twelve months.

Portfolio A will double in nine years; Portfolio B takes 24 years to double–by which time Portfolio A will be almost 4x the value of B.

People untrained in academic finance would opt for A.  Academics argue (with straight faces) that the results of A should be discounted because that portfolio fluctuates in value so much more than B.  Some of them might say that A is worse than B because of greater volatility, even though that would be cold comfort to an investor aiming to send a child to college or to retire (the two principal reasons for long-term savings).

more interesting stuff

–on the most basic level, if I’m saving to buy a car this year or for a vacation, that money should be in a bank account or money market fund, not in the stock market.  Same thing with next year’s tuition money

–the stock market is the intersection of the objective financial characteristics of publicly-traded companies with the hopes and fears of investors.  Most often, prices change because of human emotion rather than altered profit prospects.   What’s happening in markets now is unusual in two ways:  an external event, COVID-19, is causing unexpected and hard-to-predict declines in profit prospects for many publicly-traded companies; and the bizarrely incompetent response of the administration to the public health threat–little action + suppression of information (btw, vintage Trump, as we witnessed in Atlantic City)–is raising deep fears about the guy driving the bus we’re all on

–most professionals I’ve known try to avoid trading during down markets, realizing that what’s emotionally satisfying today will likely appear to be incredibly stupid in a few months.  For almost everyone, sticking with the plan is the right thing to do

–personally, I’ve found down markets to be excellent times for upgrading a portfolio.  That’s because clunkers that have badly lagged during an up phase tend to outperform when the market’s going down–this is a variation on “you can’t fall off the floor.”  Strong previous performers, on the other hand, tend to do relatively poorly (see my next point).  So it makes sense to switch.  Note:  this is much harder to do in practice than it seems.

–when all else fails, i.e., after the market has been going down for a while, even professionals revert to the charts–something no one wants to admit to.  Two things I look for:

support and resistance:  meaning prices at which lots of people have previously bought and sold.  Disney (DIS), for example, went sideways for a number of years at around $110 before spiking on news of its new streaming service.  Arguably people who sold DIS over that time would be willing to buy it back at around that level.  Strong previous performers have farther to fall to reach these levels

selling climax:  meaning a point where investors succumb to fear and dump out stocks without regard to price just to stop losing money.  Sometimes the same kind of thing happens when speculators on margin are unable to meet margin calls and are sold out.  In either case, the sign is a sharp drop on high volume.  I see a little bit of that going on today

 

more on Monday