Heisenberg Report

The Macro Case For Buying Stocks After This Week’s Surge Is Very Weak Indeed

“A lot of the moves this week have been explained by a relief rally that the coronavirus seems to be slowing somewhat”, Mark Heppenstall, CIO at Penn Mutual Asset Management, told Bloomberg on Thursday.

I don’t know, folks. As I put it Wednesday evening, I’m not sure it makes sense to suggest that risk assets are rallying because of anything to do with the coronavirus. Rather, risk assets are rallying because of other things (e.g., a deeply-ingrained Pavlovian instinct to buy dips in an environment where central banks have committed to keeping the liquidity spigots open) and in spite of the worsening epidemic.

I think the key point is as follows (from the same Wednesday evening post linked above):

It’s true that you can annotate an S&P futures chart for key virus headlines and clearly identify spikes on ostensibly positive news. But you’d have a pretty hard time making the case that the pandemic story has improved enough over the past 72 hours to warrant one of the best 3-day rallies for equities in a year.

This week’s econ out of the US has been decent, but German factory orders served as a stark reminder that key cogs in the global economic machine were still malfunctioning even before the virus scare.

And let’s face it, there is nothing that screams “economic boom” in the following simple visuals:

Stocks are, frankly, disconnected in many ways, and the overarching point from the bottom pane is that while the Fed’s insurance cuts (and balance sheet expansion) have certainly helped levitate equities, monetary policy has not succeeded in lifting inflation expectations.

Allow me a brief aside. What’s different about me (and this is one of the main reasons people spend time perusing these pages) is that I’m not invested in promoting any particular narrative (bullish or bearish) and I have no bias one way or another when it comes to near-term market gyrations.

To be sure, I’m no Warren Buffett over here – my investment horizon is not “forever” and I do occasionally think “tactically”, if you will. But, as I told my buddy Kevin Muir (of Macro Tourist fame) on Wednesday, if I’m not comfortable holding onto something for at least one full year, I generally don’t fool with it. Over the years, my biggest shortfall as a market participant is being unwilling to let my winners run. I have a pernicious tendency to book gains quickly. Too quickly. Like, “you’re up 5%, take it and run!” type quickly. To be sure, there’s nothing wrong with that. A bunch of 5% gains add up over time. But once you’ve seen a few things run like they stole something after you cashed out, you eventually just decide it’s better to confine yourself to trades based on a thesis that’s got a shelf life of more than a month. For me, that takes most of the emotional component out of things.

The reason I bring that up here, is that thinking in those terms allows me to deliver unbiased assessments of the near-term outlook. I’m not emotionally (or financially) invested in what happens over the next month (or two months or three months), so my takes are as free from spin as they can be, taking into consideration that I’m only human.

And with that in mind, I have to say that I’m having a difficult time discerning any overtly bullish macro narrative that justifies piling into equities after the last four sessions (i.e., after the bounce off the virus panic pullback). S&P futures are now more than 4% off the Friday lows.

Info Tech has run 5.3% in four days. That’s double (on the upside) Friday’s losses in tech land.

Analysts are taking note. Everyone is quoting Citi’s Tobias Levkovich on Thursday. “Pretty much every client we talk to wants to buy the dip”, he wrote. “And that is not comforting”.

I don’t think that’s the right way to frame things. It’s not the classical conditioning that’s disconcerting. After all, who can argue with liquidity provision and what now seems like another date with the zero lower bound?

There may well be plenty that’s irrational about the policies, but as long as the economy doesn’t appear poised to fall off a cliff, there’s nothing irrational about being bullish when liquidity is abundant and rates are falling.

So, the problem isn’t so much that folks want to buy the dip. They’re backstopped – or at least they feel like they are.

The problem, rather, is that nobody knows what the economic hit from the virus is going to be. By almost all accounts, it’s going to be dramatic in China. On Wednesday, Fitch suggested Chinese growth could slow to 3% in Q1. On Thursday, Nomura’s Ting Lu said this:

In all scenarios, we envisage a short-term growth slump followed by a V-shape recovery, driven by strong pent-up demand. The only difference lies in the scale of the growth slump and the timing of recovery. In the five scenarios, Q1 growth drops to 3.8%, 2.5%, 2.0%, 1.0% and 1.0%, respectively, from 6.0% in Q4 2019 but, thanks to the expected recoveries after the nCoV-related lockdowns end, annual GDP growth in the five scenarios slows to 5.6%, 5.3%, 4.8%, 4.2% and 3.9%, respectively in 2020, from 6.1% last year. Year-on-year growth could surge in Q1 2021 on a low comparison base. We revise down our real GDP growth forecast for Q1 and full-year 2020 to 3.8% and 5.6%, respectively, from 5.8% and 5.7%, as we assign the highest probability to the “good” scenario.

“V-shaped” recovery or no, there is exactly no chance (none) that the market will react rationally to a 3-handle quarterly GDP print from China, where “rationally” means taking it completely in stride knowing it will be recovered later, after the virus is brought under control.

(Nomura)

That worst-case scenario from Nomura (annual GDP growth of 3.9% from China) is unthinkable. And I don’t mean it’s not possible. It’s entirely possible depending on the severity and longevity of the outbreak. By “unthinkable”, I mean that if Chinese growth slows to 1% in Q1 and Q2 (which are the assumptions for that worst-case scenario), it’s hard to imagine how risk assets could possibly hold up. That scenario would mean (almost by definition) that either Chinese policymakers failed in their stimulus efforts or they didn’t try hard enough. Either of those outcomes is bad news.

To be clear, there are credible (and highly convincing) flows-based arguments for why equities can keep running in the absence of any overtly dour news out of China. But with corporate profits in the US having contracted for two straight quarters and the Fed unlikely to move aggressively in the very near-term, it’s hard to make a fundamental case for chasing stocks up here on the heels of this week’s rally.

I just don’t see it. But then again, I’m pretty conservative in my approach to markets. I suppose that’s the way I compensate for all the risks I’ve taken in the “real” world over my decades on this planet.