Macro Monday: A Depression Walks Into The Fed And Finds Robin Hood’s Diary


Summary

  • The rally off of the March 23rd bottom has been spectacular on combination of extreme Fed monetary policy and young investor Hopium.
  • The rally has shown signs of exhaustion in recent weeks, but that also happened from late April to mid May.
  • A massive head and shoulders pattern that began in 2016 has developed, suggesting a large leg down for stocks is coming.
  • But, but, but, the Fed and a “V” shaped recovery could make the bad things turn invisible, just like magic.
  • There’s no such thing as magic, only illusion.

The broad large cap stock market universe, represented by the SPDR S&P 500 ETF (SPY), continues to rally and flirt with breaking out to new all-time highs. The tech, communications, healthcare and consumer discretionary heavy Nasdaq 100, measured by the Invesco QQQ ETF (QQQ) is already at new all-time highs: 

Chart
Data by YCharts

Investor enthusiasm is pinned to two ideas. First, are hopes for a “V” shaped recovery in the economy as championed by Morgan Stanley (MS). Second, is a belief that the Federal Reserve has as much magic monetary potion as needed to pump up stocks despite all-time over-valuations.

As you have heard me discuss in webinars since early 2018, investors must be very wary of high unemployment. As the unemployed begin to fall behind on bills, they are apt to turn to cashing in their retirement plans, which in turn leads to forced selling of stocks. Economic indicators are flashing red alert danger signals. Investor Will Robinson does not seem to care. 

This week I will talk about the “V’ shape recovery prospects, the Fed’s magic money, as well as, provide a few pertinent charts and video clips. 

Economic Indicators Are Dire

The world is experiencing its worst economic downturn in 90 years. 

ISM New Orders
ISM Employment
Labor Force Participation Rate

GDP Growth Rate: GDP Levels By Year:

I believe the World Bank is overestimating U.S. growth, but even if not, it will take the whole of 2021 to get “back to go” or more likely, into 2022.

Here’s what the Atlanta Fed just said: “The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2020 is -45.5 percent on June 17, down from -45.4 percent on June 16. After this morning’s housing starts report from the U.S. Census Bureau, the nowcast of second-quarter real residential investment growth decreased from -23.3 percent to -25.9 percent.” 

Understand that to mean that GDP in Q2, not annualized, will be down about 45% from last year’s 2nd Quarter GDP. 

What does that say about consumer spending?

Consumer Spending

How do the unemployed spend at the levels they did when employed? How do they even pay their mortgage and other bills? Maybe this?

via Bloomberg

The damage isn’t just in the U.S. of course. From the IMF:

OECD

Here is the OECD’s comparison of one wave of COVID-19 versus two waves: 

That’s pretty bad. Two waves is worse: 

OECD GDP 2 Waves COVID-19

Of course, lower GDP impacts corporate earnings. That might be important if valuations matter. Stocks Are Still Overvalued – Does It Matter?

Don’t Believe The Hype On A “V” Shaped Economic Recovery

Morgan Stanley is leading the charge for a “V” shaped economic recovery. Multiple billionaire investors, major business owners and corporate executives say otherwise. 

(clean)

Probably the most important reason the economy won’t see a “V” shaped recovery is that people are afraid of getting sick. Although COVID-19 doesn’t kill many young healthy people, we have learned it can cause damage. We are also learning that herd immunity is not likely without a vaccine because we are seeing people get the disease more than once. 

COVID-19 Infection Rate Rising

Folks have new reason to be afraid of getting sick. The percentage of people getting infected is rising. As we saw with the MIT machine learning estimates that have been the closest I have found, the reproduction rate has crossed back above 1. That is, for every person who has Coronavirus COVID-19, more than one person is getting it from that person. 

Mind you, that is without a second wave. 

Consider this, the wealthiest 25% of Americans cut their expenditures the most. For the most part, folks in the upper 25% of wealth are older. Generally, Silent Generation, Boomers and Xers. They are also the most at risk. They aren’t going out to spend and there’s only so much to order on Amazon. 

Here’s an example: I’m 50, so on that older younger divide called middle age. I don’t go out anymore except to do some masked shopping and a couple times to eat on outdoor decks. I like poker in casinos and bars and basements. There’s no way in heck you catch me in any of those places before there is a vaccine. I think that type of approach is pretty common. 

So, while younger folks are out and about, their wallets aren’t as fat as those who are cooking at home (I have some great new recipes), while catching up on years of missed television and movies. 

So, here’s my $23 trillion question. How does the economy improve if only some of the people who were spending in 2019 go out and spend before there is a vaccine for COVID-19?

The answer is that the economy cannot and will not get back to 2019 levels until people are willing to go out and spend again. A second wave kills that possibility. Literally. 

Even when there is confidence and spending starts to advance past initial rebound bouncy levels, it will take time for the economy to improve back to 2019 levels.

I do not believe we see 2019 GDP equivalence until 2022. Although, by the second half of 2021, we could see a very rapid normalization if there is a mass distributed vaccine by the end of the first half of 2021. 

Again, I ask, what does that mean for corporate earnings? And, does it matter? Or, is it different this time?

The Magical Mystical Federal Reserve

The Fed has taken unprecedented steps to bail out the bond markets. Some of that money does flow to the stock market after being washed through other mechanisms. All totally legal now due to new laws recently passed and very loose interpretations of those laws by the executive branch.

Debt Held by Federal Reserve

What that chart tells me is that the government and Fed will have their hands full containing interest rates once the economy is nearing full strength in a year or two. 

What is more important in the shorter term, is that a lot of people think that the Fed will continue to support asset markets, believing that is the Fed’s primary goal, at least through the election. Chairman Powell was of course a President Trump appointee and they have a well chronicled lovefest (no, not really).

Fed and the stock market

I would suggest that the Fed is actually just trying to make sure that companies, government entities and small businesses don’t go under while we wait another year or so to resume some economic normalcy. Corporate borrowing rates have plunged. So far, states and cities haven’t had to declare bankruptcy as suggested by Senate Majority Leader McConnell. 

Corporate Borrowing Rates

I could be wrong. Maybe it is all about the stock market. 

Money Printer Go Brrr

On Reddit, there are a lot of memes that make the rounds. One of the most popular right now is the “money printer go brrr.” This is a reference to the Fed money printing exploits and the idea that the Fed makes sure that “stonks” only go up. It’s a very common mindset that it’s almost impossible to lose money in stocks right now. 

I have been monitoring Reddit investor subreddits (message boards) since last year. Reddit has become a semi-important website for semi-organized and semi-informed young investors.

One of the most popular subreddits is called WallStreetBets which was founded in 2012 and now boasts 1.3 million users. Says the founder Jaime Rogozinski (per WSJ): 

“They don’t know what they’re doing,” he says, “and they don’t care that they don’t know what they’re doing.”

Adds Mr. Rogozinski, “To them, there’s no sense in looking at a company’s balance sheet or figuring out how to do a discounted cash-flow analysis. They just regard the volatility as an opportunity for fun.”

I just bought Rogozinski’s book:WallStreetBets: How Boomers Made the World’s Biggest Casino for Millennials

I suggest you buy it to help understand today’s markets. It will be the 3rd or 4th book we read in the soon to be announced “Investment Book of the Month” group. 

Here are a few articles about Reddit: 

There’s a loud corner of Reddit where millennials look to get rich or die tryin’ 

Published way back in 2016, this article was a harbinger of thing to come.

Reddit’s Profane, Greedy Traders Are Shaking Up the Stock Market

Playing the Market Has a Whole New Meaning (possibly paywalled)

Chronicles the fast trading, smart talking ways of subreddit “WallStreetBets.” I follow this forum fairly closely, though rarely contribute. I’m a lurker. What I’ve found is a lot of very uninformed wannabe traders with a sprinkling of truly gifted traders and investors. A common thread is smart alec replies, memes and calling profits “tendies,” as in chicken tenders, which are, tongue in cheek, highly coveted. 

A Guy on Reddit Turns $766 Into $107,758 on Two Options Trades

Most traders can’t or won’t prove their brags, but this guy did. He made a pair of very high risk, very easy to lose it all, trades, that worked out. Sort of like hitting green on the roulette wheel two bets in a row. He’s emulated. 

Reddit has become the gospel of personal finance

I think this piece overstates it since there is a world of crummy information to wander before you find the good stuff, but, a lot of Millennials are using Reddit for financial advice, there is no doubt. They are eschewing experience in favor of their own common generational viewpoints. In many ways it morphs into group think. 

Ultimately, Reddit requires a lot of work to make useful. It’s not the free shortcut to knowledge many want to believe it is. In many ways, it’s a twice removed part of the many bad information machines that are out there. If you ever complained about something that didn’t make sense on Seeking Alpha, ha, get a counting machine for Reddit.

Many of the subreddits, particularly WallStreetBets, perpetuates a risk taking attitude among younger investors. While winning, ignorance is clearly bliss. And, when they lose, YOLO – you only live once! 

One last thing, and I won’t prove what I’m about to say, so take it for what it is worth, but, I know some people, who know some people, who know some people.

I am fairly certain that the Reddit trading crowd is being fed investment narratives by hedge fund managers playing the long game. To be clear, I don’t think the hedge fund managers goals are altruistic. 

Robinhood No Longer Steals From The Rich

Closely intertwined generationally with Reddit, is online trading app, new word for brokerage, Robinhood. It’s initial claim to fame was “free trades” which every firm has now. Now, it’s just another firm that sells information about users and tries to sell more products. 

I signed up for a Robinhood account a couple months just to see how it operates. It is designed to keep you VERY informed.

The information you get is an alert every time the price stock you own or are watching moves a few percent. It’s very exciting. You can adjust your settings, but most people don’t by nature. The result is that see a lot of exciting alerts. The alerts really help you trade. A lot. Like a lot, lot. 

The Robinhood research is hard to get to on your phone or computer. I couldn’t find research reports that major brokerages have. It does have a pretty layout with blurbs on “bulls say” and “bears say.” They also have a “100 Most Popular” stock list which seems to thrive on itself. 

They are also now offering crypto currencies, as well as, planning a rollout of personal finance services including loans and credit cards. Did I say that Robinhood had a pretty layout? 

Robinhood traders cash in on the market comeback that billionaire investors missed

I’m pretty sure the trend in that article will hold (or not).

Valuations Have Always Mattered Eventually 

These charts are a few weeks old. Valuations are worse now.

Stock Market Valuations
Comparing 4 Stock Market Valuations
Buffett Indicator
Buffett Indicator Close Substitute

Technically Speaking

This is the S&P 500 ETF (SPY) chart we have been working off of for about two months now. I’ve put some useful annotations. 

SPY Trend

In short, the head and shoulders formation is frightening. In order to invalidate it, the S&P 500 needs to set new highs. With the Invesco QQQ already at new highs on rampant speculation, the SPY could very well set new highs (money printer goes brrr). 

However, we have seen a violation of the long-term uptrend already. The 200 week moving average is a very important long-term trend level historically. Each yellow box marks a potential structural consolidation range that could see a reversal. 

The Invesco QQQ ETF (QQQ) would likely be in the $190s with SPY around $280. Here is some recent history:

Chart
Data by YCharts

I put the odds of the bull market holding up and continuing, with any violations of a SPY price of about $279 lasting less than a 6 days being about 20%. In this scenario, we just witnessed the fastest bear market in history and it’s back in hibernation. This could very well be. But, for me, as a risk manager first, I want to see the proof in the porridge. 

I put a bear market with the SPY dropping substantially below $279, potentially as low as 208, being about 60%. Severity will depend on vaccine progress and how much the money printer goes brrr. 

I put the probability of the Armageddon scenario being about 20%. I defined the Armageddon scenario in  ‘To The Moon’ Vs. ‘Coronavirus Crash II’ Vs. ‘Armageddon’ as the combination of all three of these things happening: 

  • A wicked second wave of Coronavirus – possible, if not probable, but not enough to sink us much further than the 210-190 range on the SPY by itself.
  • A drying up of Federal Reserve and U.S. Government relief efforts.
  • Trade conflicts leading to massive disruptions of supply chains as politicians jockey to avoid responsibility for not handling the pandemic well.

Investment Thoughts

I have some very simple investment thoughts. 

Bulls will want to be buyers of stocks with the SPY in the $280s if downward momentum is leveling off and oversold levels on short-term daily charts are met. Those who are extremely heavy in cash will want to nibble on their very favorite investment ideas regardless of viewpoint as insurance against a bull market being intact. 

Bears will want to scale in as the SPY breaches $270 and oversold levels are met on the daily charts and approached on the weekly charts. Use each yellow box to allocate a predetermined fraction of your investable assets: One-third, one-third, one-third is a simple and generally effective approach. 

Those expecting or overwhelmingly afraid of the Armageddon scenario, well, you should be 100% in cash and short-term bonds, own some gold coins and minibars, as well as, have at least a partial stake in some farm land. 

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.