The Dividend Cafe - Daily Covid and Markets Podcast - Tuesday, May 12

Episode Date: May 12, 2020

In the height of market violence throughout March and April it was routine that the overnight futures would do one thing, the opening the next morning something totally different, and the action throughout the day something different still. Sometimes even then there was no clarity as to how things would end up as 400+ point moves down or up even in the final hour of trading were extremely common (either as reversals or pile-ons). Lately the futures I have seen before bed time, the futures I wake up to around 3:00am, and the market opening levels have all been pretty in line with one another. There have been late day trading reversals (as I highlighted most days last week), but the futures and the opening levels have been pretty consistent. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Hello and welcome to today's COVID and markets brought to you by the Dividend Cafe. This is David Bonson. I'm the Chief Investment Officer at the Bonson Group. A bit of an action-packed day and we're going to go through our normal categories of information to give you a little update in all things COVID-related and how they're affecting markets and economy. As I went to bed last night, the futures were pointing to a down 200-point day in equity markets. And then when I woke up at three in the morning,

futures were flat. And by five o'clock in the morning, the futures are pointing to 120-point move higher. The market opened at 6.30 a.m. Pacific, obviously flat. And it traded pretty much flat to modestly down throughout the day. And then again, in the very final hour of trading, we've seen this quite a bit lately, there was quite a big move. And in this case, it was to the downside. The market closed in the Dow down over 450 points. The S&P was actually down even more on a percentage basis. And again, all of that coming in the final hour of trading. Now, it's interesting because the level of normalcy in the markets now versus

four weeks ago, six weeks ago, eight weeks ago is a totally different universe. But with that said, markets are still nowhere near normal and unpredictable behavior is going to continue. Underlying uncertainty, volatility and erratic price action is to be expected both for good and for bad. In terms of today's COVID markets, though, on the health data side, we do actually have some of the best news that I've had to report since I began doing these daily missives. And so let's jump into that, and then we'll come back to some of the market discussion. We did on Monday enjoy the lowest case growth as a percentage since the crisis began, just 1.4% case growth here in the U.S.

The most visible drop in absolute number of new cases as well. We were at about 18,000 plus change yesterday, and we were over 22,000 a week ago same day. So a 16.5% decline week over week. Monday featured the highest daily testing number we've seen so far, 394,000, which was a surge behind 113,000 new tests that were done in New Jersey. And we had a low in positive tests as a percentage of total tests, just 4.6% yesterday, Monday. Now today's data, we did again reach over 300,000, about 306, 307,000 new tests and a positivity ratio of just 6.6%. So the reason why I continue to hit this point home is that we went for weeks averaging about 140,000 tests a day and averaging right around 20% positive ratio.

tests a day and averaging right around 20% positive ratio. We're now averaging, let's call it 300,000 tests per day. And right now, a positivity ratio that's been in the single digits. So really encouraging news in that regard. I would point out too, just to keep this half full glass half full, that we have not seen any case pickup in Georgia, Tennessee, or South Carolina, which have led the way in economic reopening. It's not to say that we won't see any pickup there, but so far we have not. And that matches a lot of what we've seen in Europe as well, where some of the countries that have led the way in reopening have really had pretty benign data since their reopening. I will point out, because I got into some of the sports leagues plans yesterday, that Major League Baseball did indeed present their kind of master plan for salvaging their 2020 baseball season. And I'm not particularly surprised, but the Players Union

is pushing back on some things. And I'm hopeful that there'll be agreement in the days ahead. But this is not something I could bet firmly on that the union and management will come to an agreement. But at least it does speak to some of those, you know, kind of high level efforts towards normalization being made. Definitely not a surprise, but Broadway in New York City, the theater district, is not going to be reopening over the summer. I don't think at this point very many people expected they would. Although their new target of Labor Day weekend would be very encouraging.

I'm not totally sure, based on state and local guidance, where they'll be with that either, but targeting that September 6th, Labor Day weekend, to see the Broadway Theater District come back to life in New York City. Moderna, one of the leading vaccine programs, did receive their fast-track designation from the FDA. They're prepping both Phase 2 and Phase 3 trials right now as a leading vaccine candidate. And so the world is watching to kind of see how quickly some of these things can continue through their very pivotal clinical trials. I would point out because Switzerland is certainly a model country in a lot of ways as it pertains to a number of categories that come up in the realm of policy.

And their reopening, not just retail storefronts and so forth, but restaurants, sit-down, has been quite an interesting model for safety and economic well-being. And it's important to note some of the European countries are having success with their attempts to get their economies normalized. Market technicals. The only thing I kind of want to really focus on here is the regularity as opposed to abnormalcy of the market performing very well through a period of awful payroll reports. My friends at Strategas Research ran a couple reports where you look back at some of the worst payroll reports you've ever had, and you've actually had very positive stock market performance throughout.

And they specifically highlight, and I put charts to this effect at covidandmarkets.com today, the 1974 recession where we were just suffering through really brutal, prolonged unemployment issues and the stagflation of the 1970s. And then, of course, the 2009 atrocity through the great financial crisis. But they both saw the same thing, which is that by the time the worst unemployment report came, the market bottom had already happened. And again, we see this with the gift of hindsight. Now, another way of saying it is that it's common that markets will be going higher even as unemployment is still worsening. The point being that the worst payroll report often comes after the market bottom in hindsight.

And so I think the empirical confirmation, just to provide that historical reference, is useful and perhaps actionable. But I also think a theoretical explanation is important. And it is something I've been saying over and over and over again over the last several weeks. and over and over again over the last several weeks, that, of course, markets are forward looking, but also that markets overshoot on the downside in every panic sell-off, so that when markets recover, a lot of the quote-unquote recovery is really just making back the first part of excess that had sold off. Then, when markets begin to assess the future, prices reflect more than just current headlines, but rather anticipation of the future, which sometimes can be many months out. And additionally, when markets are pricing in their view of the future, they're doing so with a view to the relative reality of the marketplace, what the other risk-free assets, what other risk-free assets are offering by way

of comparison. So markets can be wrong in the way that they assess these things, but I would argue that investors are wrong a lot more than markets are. Some other technical observations before we move on, the financials, particularly regular conventional banks, continue to be the weak link in this market. Health care has continued to shine, but not just big pharma. Small cap, biotech, everything in between as well. A lot of positivity in the health care sector.

The small cap area is really beginning to sustain some technical strength, particularly where higher quality factors exist. So I think that there is a heavy portion of small cap that is not profitable and is more debt levered and so forth. But in terms of higher quality companies from a balance sheet and financial performance standpoint, you're seeing a lot of technical strength into the small cap area. And then finally, the VIX, it got as low yesterday on Monday as it was before the real COVID market distress started in kind of late February. It was the first time that we saw the VIX back down around 27 or so, which the last time we had been in that 27 range, mid to high 20s for the fear index, was indeed near the end of February before everything kind of hit the fan. Now, of course,

just as soon as I say that, the VIX popped up almost 20% today, back to about $33. On the public policy front, Secretary Mnuchin yesterday showed the clearest signs to date that he is bending towards making the PPP guidelines less restrictive and more flexible. The two areas where flexibility needs are most highlighted continue to be in A, the length of time loans can be held on due before requesting forgiveness, something longer than the current eight-week allotment. And B, more bandwidth in how funds are spent to still be eligible for loan forgiveness. It's currently requiring 75% be devoted to payroll. forgiveness. It's currently requiring 75% be devoted to payroll. There's been a lot of push to try to see some of that lessened a little bit to accommodate other business models. First of all, an inspector general report's already come out and said that the guidelines offered by Department of Treasury and the SBA after the legislation passed were excessive relative to what Congress had actually passed in the CARES Act.

Now, I think Treasury's position is, no, we have the leeway there, and I'm not sure what a legal argument would be, but there's already been kind of interdepartmental opposition. Additionally, there's been so much open lobbying for some greater flexibility, and it hasn't let up. So, look, Secretary Mnuchin is not fully capitulated here, but he's referred to being open to technical fixes. And I think generally that language usually is a precursor to some form of adaptation. As for the stimulus 4.0 package that I think we're eventually headed towards. Speaker Pelosi's House bill,

which they've titled the HEROES Act, was leaked out today and it's calling for $500 billion direct to the states, $375 billion direct to local municipalities, $175 billion for a social services emergency fund, $20 billion for tribal relief, Indian reservations, $75 billion for housing assistance, $25 billion for the post office, $10 billion for small businesses, and then $3.6 billion for election contingency planning. It's all early negotiating moves by House Democrats. It's not a serious attempt to legislation. There's been no intersection with the White House, let alone Senate Republicans yet. And my sources tell me that's two to three weeks away. So the beat goes on. I'm going to kind of skip over some of the things I say at

covidandmarkets.com today about oil and energy. Oil, first of all, was up about 5% today, hitting the $26 range for WTI crude. But I do want to kind of just give you either a warning or tease it a little that I really am embarking on pretty heavy study into this idea that the U.S. and Saudi relations may be very different for some period of time to come. And when I say different, I mean different than something that's really been pretty baked in to the US geopolitical assumptions for decades. Saudi had $27.5 billion fall in currency reserves in the month of March. We haven't got April's number yet.

I expect it will be. And so I just sort of think that what we're facing is a lot of pressure for the U.S. to continue being there for Saudi. Remember, they peg their currency to the U.S. dollar. And yet the U.S. is increasingly feeling that they're providing a lot of geopolitical support and not getting a lot in exchange economically. And so if both sides feel estranged right now, that could go in a direction that could have a lot of implications. Yeah, in oil and commodity prices, but also in currency and in national security.

in currency and in national security. In housing, just to be very candid, the increase in loans that are in forbearance went from 7.54% to 7.91% last week. That was much less than I expected, so I'm really happy about that. It's very good news. I think 7.91% on an absolute basis is very high to have that many mortgages in forbearance right now. It's higher than we wanted to see.

But the week-over-week pace seems to have slowed quite a bit, and that would be a very good thing. very good thing. As for new purchases of housing, we've seen purchase loan rate activity about 15% per week less than the corresponding week of a year earlier over the last six weeks or so. And I've been surprised that the number was not greater. And then now this week, purchase rate locks were only down 8% year over year. All signs of a pretty robust new purchase market. But I think the caveat's important. It's more or less entirely in the conforming market, where the loan amount is $510,000 or less,

that you're seeing healthy activity. They conform to the Fannie and Freddie standards. The jumbo market, more subprime market, with even subprime within FHA, it's pretty much frozen entirely. The low market for investors, people buying spec or income property, is almost completely broken as well.

In Fed news, they did officially begin their corporate bond buying today. Obviously, these facilities have been telegraphed some time ago. High-grade corporate bonds are up 15% since the Fed's announcement. Junk bonds are up about 14%. So they're now entering into a market that's already seen a lot of price recovery and improved liquidity conditions. How the mere announcement of Fed intervention has already resolved much of that liquidity deterioration that the space suffered in March. It's going to be an interesting fact to juxtapose with their actual purchases. But when you look today, which was by and large turned into quite a risk-off day, stocks down, interest rates didn't do anything particularly noteworthy, but you see all these different bond ETFs performing well. I think it's a natural byproduct of Fed activity.

By the way, the President of the United States was on Twitter today saying, as long as other countries are receiving the benefits of negative interest rates, the USA should also accept the gift of negative rates, big numbers. And so we just hope and pray that no one's listening to that. Negative interest rates, I think, would be one of the great tail risks for the market health of the economy to have such a massive amount of price discoveries taken out of the market and disruption to American financial markets. But I'll leave that alone.

So final closing comment here. We're really right now very excited about a number of investment opportunities that are coming out of the COVID experience. Non-traded loans to middle market companies from non-bank lenders, just call it the middle market lending area, is a space that we think is very opportunistic. The Fed's put a lot of downward pressure on yields. They've provided a lot of support, as I mentioned a moment ago, into the investment-grade corporate bond market. And that's taken away a lot of the potential reward in that aspect of

corporate debt. But when you get into very well underwritten loans with a senior position, floating rate terms that provide a lot of interest rate protection, you get big spread opportunities, some technical advantages that we think are very underappreciated. So that middle market direct lending asset class becomes an area we frankly were beginning to really turn on to even before COVID and now have become quite fond of the opportunities there. So with that said, go to covidandmarkets.com, see the different charts and things we've posted here today. And if you have any questions at all, do not hesitate to reach out to all of us at the Bonson Group. Thank you for listening to COVID in Markets.

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