it’s mostly about interest rates

There are three big categories of liquid investments: stocks, bonds and cash. Typically, the progression for individuals as they begin to save is: cash first, then bonds, then stocks.

There’s also an age-related progression, generally from riskier stocks to the steadier returns of government bonds. The old-fashioned formulation is that your age in years is the percentage of savings that should be in bonds, the remainder in stocks. A 30-year old, for example, would have 70% of savings in stocks, the rest in fixed income.

A strong tailwind has been aiding bond returns in the US since the early 1980s, since after the Fed raised short-term interest rates to 20%+ to choke off an inflation spiral spawned by too-loose money policy during the Seventies. The financial collapse of 2008 required another huge dose of money policy stimulus. Recently, Trump has been badgering the Federal Reserve to push short rates below zero to cover up the damage he has done to the domestic economy since being elected, in addition to the big hole he punched in the bottom of the boat this year by his pandemic denial.

No matter how we got here, however, and no matter how bad the negative long-term consequences of Trump’s bungling, the main thing to deal with, here and now, is that one-month T-bills yield 0.13%. 10-year notes yield 0.91%. That’s because during times of stress investors almost always shrink their horizons very substantially. They’re no longer interested in what may happen next year. They just want to get through today.

My sense is that we’re bouncing along the bottom for both short and long rates–and that we’re going to stay this way for a long time. If so, not only is income from Treasures of all maturities substantially below the 1.9% yield on stocks, a rise in interest rates toward a more normal 3% will result in a loss for today’s holders of any fixed income other than cash.

So for now at least, for investors it’s all stocks, all day long.

Looked at this another traditional way, the inverse of the yield on the long Treasury should be the PE on the stock market. If we take the 10-year as the benchmark, the PE on the stock market should be 111; if we take the 30-year (at 1.68%), the PE should be 59.5.

We have to go back to the gigantic bubble of 1980s Japan to see anything similar. If the comparison is valid, then bonds are already in full bubble mode; stocks are halfway there.

reopening rally back on?

That’s what it looks like from yesterday’s price action and today’s futures–both showing the US economy-centric Russell 2000 outperforming the much more international NASDAQ.  The latter, of course, has been the engine driving US stocks for the past 2 1/2 years.

The reason?   Trump continues to do substantial damage to the long-term prospects of the US.  That hasn’t changed.  Nor has the fact that his management incompetence has caused more American deaths that all the wars the US has been in since 1945.  But the performance differential between NASDAQ and the Russell 200 has become so massive that a significant countertrend rally is on the cards.

like a bad movie script…

That stopped in its tracks last week when Trump tweeted segregationist messages urging police to shoot/imprison demonstrators protesting the death of George Floyd at the hands of Minnesota police.  It’s not pretty to see a president eager to incite widespread domestic violence he can call out the army to suppress (something no sane person would want) simply to distract attention from the coronavirus deaths his incompetence is causing.

Suddenly the stock market was back late last week to “capital flight” mode (I’m using this term because, to me, the market has had the feel of Mexico in the early 1980s).

…swiftly tossed into the reject pile

The president basically can’t deploy federal troops into a state without local permission.  And Trump seems to have lost his P. T. Barnum-like persuasive power since wilting during the virus crisis.  Governors appear to have been appalled by his advocacy of violence during a recent conference call.

why is the market rising as this scary story unfolds?

I don’t know.  Nevertheless, this is what’s happening.

No matter what, I think internal market dynamics favor the R2000 over NASDAQ for the moment.

I think ultra-low interest rates favor stocks over fixed income or cash.

Where else would money go  …Japan?  …China?  …the EU?   …the UK?   …emerging markets?  All of these places have substantial warts, either in terms of their economies or their stock markets.  Because of this, the first step in Trump-driven capital flight, I think, would be portfolio concentration in names with global reach, dual listings or the ability to shift domicile away from the US, i.e., a shift away from R2000 and toward NASDAQ.

NASDAQ is now pulling the R2000 up with it.  I also don’t think the current situation would remain stable if Wall Street begins to consider the large damage to long-term economic prospects, to say nothing of civil liberties, were Trump to be reelected.

 

 

 

 

 

 

 

 

most of an email from Wednesday night

 I think we won’t really begin to know how bad things are going to be before we see companies report earnings for 1Q20 over the next few weeks.  And it may not be until we get well into 2Q20 that we’ll have a solid grip on what the situation is.  That’s when we’ll be able to assess whether the market has already discounted all the possible bad news.
We can already figure out stuff that should be avoided–cruise ships, department stores, airlines, the Detroit auto companies…
If a professional manager has to remain close to fully invested, meaning no more than 10% in cash (for a pension manager, the maximum cash percent will typically be stipulated in a contract), just avoiding the losers will probably be enough to do better than the market.
For me, I think the investment focus should be narrower.  I find techy businesses with worldwide appeal and little investment in physical plant and equipment are especially attractive.   This is partly because technological change is very rapid, partly because I think the Trump back-to-the-Fifties economic strategy is already doing huge long-term harm to the US economy.  If he or someone like him continues in office, I think the ability of a company to pick up roots quickly and move to, say, Canada will be a distinct plus.  I also think this flight capital idea is already being factored into stock prices (look at NASDAQ  +50.8% vs Russell 2000 -13.6% since Trump has been in office).  I wouldn’t just distribute money across the board in the -non-losers.  I’d emphasize what I think are the long-term winners.
I’m sure that there are some people buying NVDA, NFLX and ATVI not because they believe in them or even know much about them but purely to defend themselves from the possibility that conventional consumer names will have hugely bad earnings performance over the next couple of quarters.  They may not be table to quantify how bad but they’re convinced that there won’t be any positive surprises, only potential negative ones.
Assuming I’m right in what I’ve written so far, the key question for me is when/how does this market situation reverse itself.
Reversal typically comes in one of two forms: the price difference between the good stocks and the bad stocks will get so extreme that, purely on valuation, the bad stocks will start to catch up with the good ones–this is a “counter-trend rally” and tends to be short; or the economy will begin to improve and there will be a genuine reversal of relative economic momentum toward business cycle recovery stocks.  I agree we’re a long way off from that.  At some point, though, it will be right to shift holdings to more traditional cyclical names in anticipation.
To some degree, the first thing has happened already.   MAR, for example was $150 in mid-December, then $46 a few weeks ago, and is now $80.  So it’s up by almost 75% from the low.  I don’t know what will happen from here but I might be tempted at $60 to buy a little bit.  Generally speaking, though, I think this kind of stock will be lucky to go sideways between now and the time, late this year?, that we get signs that business is recovering.  I’m really not accustomed to thinking about ETFs but a hotel ETF might be the better way to go.

what Monday’s market action is saying

Over the weekend Governor Cuomo of New York said that new coronavirus hospitalizations (that is new patients admitted minus patients discharged) may be plateauing.  Similar news came from Italy and Spain this morning.

While this doesn’t imply that more negative consequences of the pandemic won’t continue to build up, it suggests that the doomsday scenario of the creaky national health care apparatus imploding won’t occur.

 

Wall Street took this news as the occasion for a rally, which continues to strengthen as I write this.  (Is the worst in stock market terms over?   ,,,I have no idea.)

A day like this is chock full of information, most of it general concept stuff rather than specific buy/sell signals.

Stocks are up by 5% plus.  One should expect that the most heavily beaten down stocks should be rebounding the most and that the relative outperformers should be lagging.  No news there.  But where are the outliers?  For example:

–hotels and resorts seem to be up close to 15%, cruise lines, too, but airlines aren’t moving

–the Russell 2000 is leading the major indices up, but even though the NASDAQ has significantly outperformed on the way down, it’s even with the S&P 500 so far today

–Zoom (ZM) continues to play its contrary role–the worse the virus news, the better ZM has been performing.  But the stock is down today, and way off its high of $160+ a short while ago.  I haven’t paid much attention to ZM but it seems to me a holder (I was one but no longer) should be figuring out how much valuation support there is for it

–oils are flat to down, despite Mr. Trump’s (dubious, in my mind) claim to have brokered a production reduction deal between Russia and Saudi Arabia (more on this tomorrow)

 

What to do?  I look for two things:  individual holdings that aren’t acting the way I think they should, and changes in market leadership, which often come when the market begins to heal itself after a sharp decline.

 

 

 

 

 

 

 

odds and ends

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.

 

double bottom?

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 so many 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.