The Premise That Nothing Bad Happens

The Premise That Nothing Bad Happens

By the time the dust settled Friday, the optimism evident in a limit-up overnight surge for Nasdaq futures had evaporated, leaving steep losses for US equities.

There are still questions around when a third round of stimulus will be agreed on Capitol Hill and Americans are facing the prospect of entire states under lockdown with all but the most essential businesses and services closed. Wall Street’s largest banks now see a historic downturn for the US economy in Q2, with Goldman grabbing headlines Friday for their forecast of a 24% contraction.

US equities had their worst week since the financial crisis, falling some 15%.

 Copper had its worst week since 2011 and is sitting just above levels last seen in 2009.

The dollar had an absolutely epic run, rising more than 4% on the week, even as Friday saw the greenback take what counts as a “breather”.

Funding stress – as manifested in forward points and basis swaps – eased a bit on the final day of a week that everyone is happy to see come to a close, but this was a harrowing five days, defined by frozen markets, USD hoarding and emergency action from the Fed to expand access to swap lines.

“The unique nature of this crisis and collapse in risk assets has exposed fragilities in the system — think leverage, think liquidity – and USD funding stresses have re-emerged despite the lessons supposedly learned in 2008”, ING’s Chris Turner wrote Friday afternoon.

“Policymakers are now in fire-fighting mode”, Turner went on to say, adding that although “the Fed and the US Treasury have the tools to address the strains in the USD funding markets and conditions will probably start to improve over coming weeks, there is no getting away from the fact that prolonged lock-downs mean deep recessions”.

Here’s a snapshot of Wall Street’s forecasts for Q2:

Gold logged a second weekly loss as investors sold everything that isn’t the dollar amid cross-asset chaos and to meet what some have described as “a massive margin call on the whole post-2010 financial asset rally”.

Oil, which was buoyant overnight following its best day in history Thursday, couldn’t hold gains. WTI plunged Friday, and was down 29% for the week, its worst weekly loss since 1991.

“Tens of thousands of Texans are being laid off across the state in places like the Permian Basin shale fields in west Texas as companies shut down their drilling rigs”, Bloomberg wrote Friday, citing Ryan Sitton, Texas Railroad Commissioner, who has been invited by OPEC Secretary General Mohammad Barkindo to make an appearance at the cartel’s summer meeting in Vienna.

Sitton is proposing a joint-output cut. He had this to offer in a tweet:

As you can imagine, some are skeptical.

This was – as discussed on Thursday evening in “Swan Song“- an unfathomably bad week for the IG credit ETF. The losses are mind-boggling.

Suffice to say credit ETFs are undergoing their most strenuous stress test ever, as markets ponder the prospect of severe stress for an over-leveraged corporate sector, US government bailouts for distressed companies and, in all likelihood, a wave of downgrades and defaults.

“There are just no bids for the bonds”, one person I spoke to Friday remarked.


At the end of the day, there will be no sustained bounce until the coronavirus epidemic shows definitive signs of having peaked in western nations.

On that score, Friday was a dark day, indeed. Italy reported 627 deaths in the past 24 hours, and France said its infection total jumped 1,617 over the past day to 12,612. US cases continue to climb by the hour.

“So what happens next? On the virus side we and likely no one knows, but we are not expecting a significant improvement and macroeconomic fundamentals have significantly deteriorated”, JPMorgan’s Marko Kolanovic writes. “On the structural flow side we think conditions will improve with large option expiry [seeing] a meaningful portion (~1/3) of short gamma expiring [which] should reduce the chop and volatility going forward”.

“By suppressing volatility, central banks created a system unable to deal with bad news”, SocGen’s Andrew Lapthorne put it recently. “Leverage was built up on the premise that nothing bad happens”.

It’s worth noting that Friday was the first day in history that the S&P fell 4% while the VIX closed lower.


 

9 thoughts on “The Premise That Nothing Bad Happens

  1. That Lapthorne quote is about as true as it gets…….I am certain a lot of people saw it coming but Lapthorne managed it in two sentences…I love simplicity from time to time…..and in this case it borders on Objective criteria….

  2. H – what is the SPY down 4% and VIX down also? One theory may be since the VIX is a measure 30 days out, they r selling vol expecting pandemic improvement news? Same goes for SKEW.

  3. I am seeing an increasing number of stocks trading at valuations equal to or lower than the 2008/09 trough. Filtering those down to names with enough cash + credit lines to survive even a horrendous 2020 still leaves a decent shopping list. “Horrendous” being defined as the largest revenue declines ever seen, sometimes greater than 50%, varying by sector.

    Granted, these companies are the opposite of sexy, often are secular non-growers in uninspiring industries, and often have mediocre returns, very substantial debt and/or poor long term prospects. Some are the same names I bought in early 2009.

    At the same time, I’m seeing many stocks that have held up relatively well, in valuation and absolute price, because they are in defensive sectors, have very strong cash flow, pristine balance sheets and/or powerful long term growth stories. Some of these are household names.

    I know which I’m going to buy, and they aren’t the ones that haven’t been puked yet.

    As for the broad indices, I don’t know when this bottoms, but I think not yet and not here. If you look at the 2008 chart, there were some seeming recoveries, even after Lehman, before the final slide.

  4. Sorry, not saying.

    However, just as an example of what fundamental investors should be (and are) doing: I’ve been modeling out the major airlines, assuming anywhere from 70% to 40% of flights cancelled and load factors falling to 30% in 2Q-3Q before improvement in 4Q and a fairly normal 2021. This implies -60% revenue decline in 2020, which is shattering, never before seen, 2001 looks like a mere “blip” compared to that. Assume very aggressive cost cutting actions – massive furloughs, dividend suspensions, slash capex. You can get a sense of which ones will probably run out of cash and revolver by end 2020 – and which ones probably won’t.

    Then do cash flow valuations using fairly severe discount rates – 8% to 10% – and low terminal growth rates – like 2-3%. The ones that probably won’t run out of cash look like doubles from here, the ones that probably will (but may get bailed out) look like triples. You wouldn’t want to put too many marbles in the latter, since we don’t know how onerous the bailout conditions will be, but some marbles might be good. The former have less upside, but less risk, so some marbles there too.

    You’d go sloooow on investing the marbles, since we’d not hardly done w/ the broad selloff (my opinion) but maybe you leg it in starting here. And so on.

    This is my third go-round. In 3/2009 we were buying the most crushed names that we thought would probably survive, and that paid off. F from $1.50 to $20, TRW $3.50 to $60, etc. Avoid GM $? to $0, etc, but honestly a couple zeros are to be expected, so control concentration risk.

    In general, I think right now the list to work on is largely the ugly, uninspiring, no secular growth, maybe obscure, cyclical names that have been crushed. Don’t really care how much $ they will lose in 2020, what matters is if they have enough liquidity to avoid going bankrupt this year.

    Every account I manage has been almost completely liquidated over the past month. I’m now looking at a book comprised of about 95% cash and Treasury money market. The other 5% includes stuff I bought 2 weeks ago and have lost 20% on – ugh. If I got a new account now, and it was vanilla index ETFs etc, it might well get liquidated too. I’m not calling a bottom at all. But I’m “happier” – from a “some valuations are starting to look really good” sense – than I’ve been in years.

  5. By the way, from what I am anecdotally hearing, the bulk of retail investors have only recently just started to sell. I don’t have proof, but I “think” most of the liquidation to date has been the kind of funds that H talks about a lot. Would be interested to know if there is data on that?

    1. Our financial services industry has done a great disservice to clients and the American public by selling them on the idea that buy-and-hold is the only way to invest. A too-small percentage of retail investors — 20%?– got religion in 2008-09 and will survive this calamity; a majority, however, are going to hold on too long, with devastating consequences. The bottom is much further away than we think. Here’s why: https://medium.com/@tomaspueyo/coronavirus-the-hammer-and-the-dance-be9337092b56

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