The Dividend Cafe - Daily Covid and Markets Podcast - Wednesday, May 6

Episode Date: May 6, 2020

Happy “Flash Crash” anniversary, to those who remember that fateful day (ten years ago today). I remember it like it was yesterday, ending a meeting with clients early (who were sitting in my office facing me at the time, as I faced the television over their shoulders that was informing me of the collapsing market). I began trading in client accounts heavily after the prematurely-ended meeting, and for the first time in my life saw ETF’s broken, bid-ask spreads broken, and wild mistakes in trading execution. It was simply crazy, and only in the weeks (and to some degree, years) ahead did we really understand what had happened, how, and why. Today we don’t have a Flash Crash, and have not exactly had one since May 6, 2010. But we do have incredible risk around liquid ETF’s made up of illiquid assets. I need to attention this issue more diligently in the post-COVID months ahead. I am trying to “tighten up” the daily missive, and better organize/structure it each day around: • Health Data • Market Technicals • Public Policy • Oil & Energy • Housing • Fed News I am hoping this predictable, consistent sequence will both reflect the general priorities readers have in some way, and make for a more succinct and digestible read. And of course, I do welcome your feedback and suggestions … 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, welcome to today's COVID in Markets Daily Missive brought to you by Dividend Cafe here at the Bonson Group. This is David Bonson, Chief Investment Officer, and I'll start off by saying happy flash crash anniversary, which many of you may not know what I'm talking about, and many of you may remember it very well.

May 6, 2010, 10 years ago today. Major technical breakdown of markets, trading thrown into disarray. Market intraday dropped about 1,000 points, and back then that was when the denominator, it was a very different priced market. And so ended up recovering at the end of the day, maybe 400 points or something of its downside. But ETFs broken, bid-ask spreads broken, just wild day coming down to various technical factors and computerized errors and malfunctions and things.

And so something I remember quite well, but here we are 10 years later. And I guess that the particular events of the flash crash day have not repeated themselves and are likely somewhat improved, the capability of those things happening, but the various technical risks that exist out there, such as like what we saw in the oil market and ETFs here a couple of weeks ago, and that being sort of just a symptom of other potential malfunctions where you have daily liquid products that are backed by very, very, very not liquid products. And in a sense, I suppose that's the closest thing to a flash crash vulnerability that I think still persists out there. But I plan to give that issue a lot

more attention in a post-COVID world. In the meantime, back to the COVID world. Those that read covidmarkets.com, you're going to see that I intend to start driving each day around a more consistent format. I've loosely been doing this anyways, but I'm just trying to button up the delivery, make it more readable and digestible for people, and just kind of walk through each day the health data, the market technicals, public policy, oil and energy, housing, and then Fed news. And of course, there could be some miscellaneous nuggets that come up as well, but I'm going to sort of use that general outline day by day. And I'll start right now today on the health front.

The percentage rate of case growth continues to decline rather impressively here in the United States. And I think it's very important. I would say that the case growth decline doesn't seem to match some of the alarmism that you might be hearing still in the media in the last few days. But I'm not going to cry over that. It is what it is. I think that there's certainly some data that, you know, we're waiting on or it's requiring patience or it's not necessarily going exactly the direction that many of us would want it to.

By us, I'm referring to those who are rooting against COVID and for life and freedom. And so, you know, I think that makes up a good majority of people. And I would say that most of the data is positive and not all of it is. And the testing data is the one that's sort of a mixed bag because it's increasing rapidly, 28% week over week as far as number of tests that we're consistently doing here in the United States on a daily basis. But again, I keep reading these projections that we need to get up to about 500,000 a day, and we're sitting there somewhere around 250,000 a day soaking wet. And yet I'm also hearing that we're going to get to 500,000 in a few weeks. So I don't know why 500,000 is the daily need, Although I don't have any reason at all to dispute it, but that's where things stand.

In terms of today's testing, as of press time, we were at a little over 215,000 in the daily Johns Hopkins tracking. The positivity ratio is slipping right around 10%. It has gotten even lower. So we've seen that positive ratio of total test cut in half in the last couple of weeks from where we were averaging 18 to 22 percent a day. We're now averaging 9 to 11 percent a day. I am trying to find as much data as I can where countries and even states now here in America have reopened their economies to some degree or at least instituted some partial easing of their restrictions because I do think it's important to be able to evaluate what impact their reopening has had to their health data. For example, and there's a chart to this effect in COVID in markets today, thousands of shops were reopened in Austria on April 14th. That's

over three weeks ago now. And the health data there has been unbelievably encouraging. They're literally at a 0.2% increase in new cases. Now, hairdressers and certain service providers just opened less than a week ago, and restaurants and bars and hotels still aren't open. That'll be next week. But I mean, thousands of regular kind of retail type stores, they had their sort of phase one, phase two sort of reopening and their numbers looking very, very positive and death count declining, but really very close to zero now. The other thing I would share is just to continue with the news of the vaccine efforts. We've talked about some of the the different more prominent efforts that exist in various levels of funding, various levels of development, various levels of sponsor, academic institutions and corporate sponsors and governmental connectivities to some of these endeavors. Foundation support sometimes is behind multiple vaccine efforts at once. But the Pfizer-BioNTech

joint effort has begun human trials here in the United States with a goal of having a vaccine available for emergency use in less than four months, basically by the end of the summer, depending on how these human trials go. So we're monitoring all that as closely as we can. Moving to market technicals, it's the 2.10 spread that I think is very important right now. And of course, I refer to the spread between the two-year treasury and the 10-year treasury. That's on the verge of becoming a bullish technical indicator. A steeper yield curve would be considered more indicative of risk on, and a flatter yield curve would be considered more indicative of risk on and a flatter yield curve would be more indicative of risk off. And that 210 had flattened a bit, even as the stock market

had improved over the last five weeks. So it was kind of stubbornly avoiding becoming a bullish indicator. And yet in the last couple of days, that spread has that, you see that curve steepening. And yet in the last couple of days, that spread has – you see that curve steepening? It's not there yet all the way, but it's something that looks to us to be potentially indicating some short-term bullish signs. Speaking of short-term, 51 days in a row now, and it will be 52 with today's closure even though I haven't calculated it yet, that the S&P has moved 1 percent or more from its high point to low point or vice versa. So kind of intraday volatility being above 1%. So 52 days in a row. That's absolutely extraordinary.

It's the most since 2011, but still a long way to go to get to that financial crisis level where it happened 124 days in a row. Now, this is only a reference, by the way, to the quantity of days that are in that ultra-high intraday volatility. The magnitude of the high-low range, I can assure you, particularly at certain points in March, was like nothing I'd ever seen. at particular certain points in March was like nothing I'd ever seen. From a policy perspective, there appears to be a growing divide within the GOP leadership of the Senate and rank and file for that matter as to whether or not the payroll tax suspension is actually a line in the sand or not. The payroll tax cuts widely favored by supply siders such as Larry Kudlow in the administration. And POTUS has declared emphatic support for it publicly.

But critics are fond of lines like, well, there's no payroll tax to cut if people are not on the payrolls. But the counter argument, of course, is that by reducing the cost of having employees, you incentivize more hiring and higher wages. you incentivize more hiring and higher wages. My read on it is that some senators may very well be gearing up to sacrifice the payroll tax cut for the liability protection that they see as the top priority. I am not so sure the White House views it quite so expendably. On the PPP front, Paycheck Protection Program, I've talked to enough congressmen and policymakers in the last few days to offer a few conjectures as to pending clarifications in the PPP facility. One is I do believe they're headed towards lengthening the time that companies can spend the money they receive. It's currently just eight weeks. So they can spend that money within eight weeks and still be eligible for loan forgiveness as long as they meet the other criteria. A lot of pushback saying that that isn't enough time given a number of economic uncertainties.

And from what I'm hearing, that is likely to be adjusted. adjusted. The other big move that's being pursued, I've talked about in the last couple of days, is allowing for an adjustment of the 75% threshold minimum of PPP funds that needs to be spent on payroll in order to obtain forgiveness of the loan. And I believe that there will end up being an adjustment, just not as favorable as some groups have sought. I've spoken to two congressmen that said they want to adjust the criteria for loan forgiveness to be more favorable only where companies can demonstrate certain business hardship post-COVID. So you'll recall the whole point of PPP was that no one had to demonstrate anything. They were trying to get funds out very quickly and get funds recirculating in the economy real quickly, other than prior payroll costs as a criteria for determining the loan amount. That had to be substantiated.

Nothing else really did. So I can see them going in this direction where they say, okay, we're going to lighten the eligibility issues for forgiveness in a couple of categories, but we're going to intensify the criteria to have obtained the loan to begin with. It's hard to predict exactly where it's going, but I think some significant clarifications coming from SBA and DOT in the weeks ahead, if not sooner. Moving on real quick to oil and energy. Oil was down just a tad today, but a pretty stable day overall. It's going to be very noteworthy if the June contract expiration later this month comes and goes without the same technical and storage breakdowns that we saw

a few weeks ago. I suspect it will because I think there's two things that are very different. One is that OPEC Plus is not doing a last minute binge of production, flooding extra supply before that production cut deal that went into effect. And number two is I think the ETF world, which makes up a just insane amount of the NYMEX futures contracts, has already moved their forward contracts out well in advance of the June expiration. And so it takes away some of that risk of technical breakdown that we were seeing at the end of May. But both the June contract has moved meaningfully above its June level of support, and the July contract has done the same. So from a technical standpoint on the chart, both seem to have a good support put in, and we'll see how that holds up in WTI crude oil.

The other thing I might point out, by the way, is spreads have really kind of hung in there. They tightened a bit in the high-yield energy space. Obviously, they got to be very, very wide at the peak of market panic in March, and then they've come in a bit. But then even as the markets moved up and down and as oil prices have had their volatility, those high-yield spreads that had previously narrowed in energy, they've stayed in that range. Now, keep in mind, they're still far wider than any other sector in high-yield. Now, keep in mind, they're still far wider than any other sector in high yield. But my point is that kind of 700 basis points that they came in has stayed in. And that is pretty bullish. Some have stated, well, yeah, but the Fed was coming in supporting those markets. many energy credits that were a BBB that then got downgraded as fallen angels to BBB. Most of the energy credits were far more downstream in their credit strength from there, and so therefore have not fallen in to the Fed's recent stated support for high-yield and corporate bonds. To keep up with housing, I'm utterly perplexed by the pickup in new purchase mortgage applications

the last two weeks. Up 2% last week, or excuse me, mid-April, up 12% almost last week. That means the net decline since March is only about 25% total for those looking for a mortgage for a new property. Now, a 25 percent decline is massive, but it's nowhere near what I guess my natural intuition would have guessed and perhaps yours as well. And we are just now getting ready for parts of the economy to reopen. Auto sales, clothing, apparel, they reached down over 50 50%. So I kind of suspect that the best conclusion here is that where this economic pain is going to be most concentrated is in a sector of the economy, a demographic of the economy that really did not necessarily represent people who are likely to buy a home anyways. And that is younger people, lower income,

just primarily as a group not about to purchase new homes. So I expect new home sales will be down a lot for the next couple of months, but it may very well be that this is an economic data point where the damage will end up being less severe than feared. In Fed news, they did clarify that eligibility for the Main Street lending facility and those leverage ratios will be based on adjusted EBITDA as opposed to standard EBITDA. The distinction being that adjusted EBITDA allows you to add back various accounting adjustments. So it's a little bit less stringent of a test. And I'm not here to really comment on whether or not I think that's a good or a bad thing. Ultimately, the banks are keeping 5% to 10% of the risk of the loan on their

books. And so the banks have all the incentive to make sure that the loan is credit good. But I think you have to take that as a sign that what the Fed's signifying is a high appetite to help feed small and middle market businesses where they're willing to push the risk curve in terms of underwriting standards. So the market down about 200 points today. It was kind of flattish most of the day. And then the final half hour, third day in a row, where you had a big move and the market today went down a couple hundred points near the end of the day. Like I said, oil didn't move much. Big tech actually caught a bid today. It was up quite nicely. Kind of an odd day with market sentiment, market direction. That's all I have for today's

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