November 20, 2020
By Steve Blumenthal
“I know now we have this big debate. Is it $2.2 trillion, $1.5 trillion?
You gotta be kidding me. I mean just split the baby and move on.
This is childish behavior on the part of our politicians.”
– Jamie Dimon, Chairman and CEO, JPMorgan Chase
It seems to me that the markets are out over the cliff’s edge. Risk is elevated due to extreme overvaluations. All Road Runner needs to do is stick his tongue out and say, “Meep meep,” and Wile E. Coyote will fall. (I sure did love that cartoon as a kid though, for me, nothing beat Bugs Bunny.)
“A safety net in the Fed,” you argue. For now, likely. Fed vice chair Richard Clarida said in a speech on Monday, “The Federal Reserve is committed to using all of our available tools–not just the federal-funds rate and forward guidance, but also large-scale asset purchases–to achieve our dual-mandate goals.”
On the fiscal side, everyone is arguing for another round of COVID-19 PPP relief. That “split the baby and move on” is needed, but Washington—as you well know—is a mess.
Beyond PPP, a “make America’s infrastructure great” legislation would help the economy and get many displaced workers back to work. But it will take compromise, and compromise doesn’t appear to be in the cards until after January 20, 2021. Even then, it’s a maybe.
If your advisor calls and tells you they know what is going to happen, just know they are guessing. Safety net below? We hope.
A Three Standard Deviation Move
I find myself glued to the television watching the cartoon play out. We sit a bit too far out over the cliff’s edge for my liking. The risk is high because valuations are through the roof.
A quick refresher on standard deviation, courtesy of Wikipedia: Standard deviation is a mathematical measurement that tells us how far we are above or below a normal trend. In statistics, the standard deviation is a measure of the amount of variation or dispersion of a set of values. A low standard deviation indicates that the values tend to be close to the mean (also called the expected value) of the set of numbers. You can think of it as a measure of how spread out numbers are.
In simple terms: One standard deviation moves happen a lot. Two standard deviation moves are rarer. Three standard deviation moves almost never happen. Ultimately, everything reverts back to the mean. We are at three.
I love the following chart from Ned David Research. It plots each month-end median price-to-earnings (P/E) values back to 1980. If there are 500 stocks in the S&P 500 Index, the median is the P/E ratio of the one in the middle. The orange line in the center section of the chart tracks median P/E. Take a look at the far right. At the end of last month, the number was 34.40. A three standard deviation move above “fair value.”
Normally, overvalued would be a one SD move above the dotted green line. For us to get back to “overvalued,” the S&P 500 will need to decline 26.7%. To get back to “fair value,” a decline of 41.4% is required.
Each week I share my favorite intermediate- and long-term trend indicators in Trade Signals. They remain largely bullish. For traders, short-term indicators are flashing major sell signals, suggesting now would be an excellent time to hedge. Seconding that view, investor sentiment is back to the excessive optimism zone—thanks in large part to the remarkable November stock market rally. So much for those pre-election jitters.
My plan today was to share my notes from an excellent Dr. Lacy Hunt podcast. I’m going to bump that to two Fridays from now and take a break and enjoy a long holiday weekend. So, there won’t be a post from me next Friday. Plus, I hope to record a podcast with Lacy, and this extra time will provide more opportunity to write what I hope will be an outstanding early December On My Radar letter. Lacy is an expert on the Federal Reserve Act and Fed policy, and he believes “deflation” has us firmly in its grips. No one has a firmer grip on the Fed than Lacy. More in two weeks.
Grab that coffee and find your favorite chair. When you click on the orange On My Radar button (if you are reading this in your email inbox) or scroll down (if you are reading this online), you’ll find an excellent short note from friend David Rosenberg. He discusses COVID-19 and its impact on the economy and employment. He also paints a clear picture on the state of zombie companies. Do take a look. You’ll also find the link to Wednesday’s weekly Trade Signals post. I conclude this week’s piece with a fun note from my Aunt Sunny, and a wish to you and your family for a wonderful Thanksgiving.
If a friend forwarded this email to you and you’d like to be on the weekly list, you can sign up to receive my free On My Radar letter here.
Included in this week’s On My Radar:
- Breakfast with Dave
- Trade Signals – COVID-19 Vaccines Propel Markets Higher
- Personal Note – Happy Thanksgiving
From David Rosenberg’s Wednesday “Breakfast with Dave” research note:
More Bad News on the COVID-19 File —Looking Across the Valley? Meanwhile, as we saw with yesterday’s U.S. retail sales data and before that, the soft tone to the NY Empire manufacturing index, the economy is cooling off notably. And the surge in COVID-19 case counts clearly is at play, along with fresh restriction measures at the local government level.
The U.S. has now reported more than 11.3 million confirmed infections and the death toll has topped 248,000. The case count a week ago was 119,994 and on Monday it was 158,452.
The real startling number was in hospitalizations — 73,014 on Monday. Let’s see, before November 10th, there wasn’t a single day that we saw hospitalizations over 60,000 on a given day. ICU usage (14,313) due to the coronavirus is back to where it was in late April. And with 600,000 fewer medical professionals working now, compared to when the crisis began, for a whole host of reasons.
Investors staring at the post-COVID-19 valley is akin to staring into the abyss (restaurants know what the abyss is likely to look like—see Restaurants Prepare for a Chill in Business on page A10E of the WSJ). I also recommend a reality-check read of Retailers Are Facing a Holiday Grinch on page B14 of the WSJ.
In the past five months, retailers have tacked 1.5 million workers back onto the payroll—almost one-in-five jobs in total since May have come from retail. Let’s see how much of that begins to unwind—and is the market primed for a negative employment number soon? Or will it care if investors know that the Fed will come in with the liquidity spigots and come in hard?
We have to remember that Fed policy reaches Main Street only with a lag after it juices up Wall Street. The vaccines are sure to come and very likely be effective, but not nearly in time to prevent a renewed contraction in economic activity.
And then—what will the take-up be? Even with all this great Pfizer and Moderna news (the former now at 95% efficacy!), a New Jersey State survey finds that more than one third of residents would choose not to get vaccinated even when a safe vaccine is available.
And fewer than half (49%) say they would either “probably” or “definitely” take a first-generation vaccine. Why? Well, 80% of those who are reluctant say it is concern over side effects. In fact, a Gallup survey released on Tuesday sample size of 2,985 adults) showed 42% of Americans will choose not to get the vaccine. This could be a hurdle that the markets aren’t taking into account.
Nearly 30 Million Americans at Risk of Duress if No More Fiscal Stimulus. That abyss is the expiration of policy stimulus at the same time that the virus and hospitalization counts are on the rise. A toxic mess.
It isn’t that well recognized the extent to which the U.S. economy has a fiscal addiction. We have 12 million Americans facing an end to unemployment support by the end of the year. The CARES Act (and now the CDC eviction moratorium) prevented landlords with FHA mortgages from evicting anyone who missed their rent payments —a survey by the Urban Institute found that more than one-third of landlords (1,381 in the poll) had not been paid in full as of September.
The Census Bureau estimates that 14 million renters are at risk, based on its October 14th to 26th Household Pulse Survey. And let’s not forget the huge stimulus offered to the economy beyond checks in the bank account, which was the loan forbearance under the CARES Act, again for federally guaranteed mortgages. This runs out on December 31st. And the number here for eligible homeowners in forbearance as of November 8th is 2.7 million. So, hanging in the balance are nearly 30 million households entering into varying levels of distress as we head into 2021 amidst a do-nothing, lame-duck Congress. What does their valley look like?
In the meantime, even with the huge pile of “zombie companies,” the stresses in the business sector are on full display on page A3 of the WSJ —Federal Dollars Couldn’t Stave Off Bankruptcy for Hundreds of Firms. About 300 companies that received as much as $500 million in pandemic-related government loans have now filed for bankruptcy. Not to mention that we have a market where nearly 15% of the companies make absolutely no money.
As I said, a very speculative market. We also see Bloomberg analysis showing that, of the 3,000 largest publicly traded companies, “zombies,” or those firms who couldn’t cover their debt-service charges out of internally-generated cash flows, are now a 20% share of the market —and they have been able to add, with the help of the Fed, nearly $1 trillion of debt since the pandemic started (almost 200 companies have joined the “zombie” ranks…from 335 at the end of 2019 to 527 currently!).
That is more than double the $500 billion of debt these spurious and dubious entities had on their books at the height of the Great Financial Crisis twelve years ago. The outstanding debt for these de facto insolvent companies being allowed to hang on via Federal government/central bank assistance is now $1.36 trillion (“zombie debt” before the pandemic stood at $378 billion).
So, everyone just marvels at how there has been such a mild bankruptcy/insolvency cycle this year. Duh! I wonder why. But in the process, what the Fed has done is kept supply intact that otherwise would have been absorbed which is d-e-f-l-a-t-i-o-n-a-r-y.
Not to mention having badly managed companies stay alive through the public sector allocation of credit sort of has a Chinese feel to it—directing the flow of capital to unproductive firms.
Why does that sound un-American to me? But hey—all those buyers of CCC-rated bonds who have made an absolute killing these past two months are sure to be sending me some hate mail after that last comment (yields here have sliced below the pre-COVID-19 levels).
The era of having to do any default analysis, or anything that would remotely demand the use of a capital asset pricing model or DCF analysis, is long gone. I even had a subscriber recently tell me to please stop focusing on fundamentals and strictly stick to the technicals.
This is the market Jay Powell has delivered to us—but as we all know, for the greater good. Whoever knew that society was in such dire need of so much market manipulation? And it’s not just the airlines—it is real estate, financials, health care, telecom, consumer-related and energy. A pretty wide swath of zombies populating the business sector and the capital markets.
SB here: If you’d like to sign up for a free trial of Dave’s work, visit Rosenberg Research. I’m biased of course: Rosie is a friend and I’m also a happy client.
Three standard deviation moves and the challenges we are facing at the end of a very long-term debt accumulation cycle. COVID-19 may be calling our bluff.
Make no mistake, risk is very high. The stock market may go higher into 2021, but sometime in the next two months to two years, I suspect a -50% is in the cards. Keep risk protection top of mind.
A cliff’s edge indeed!
November 18, 2020
S&P 500 Index — 3,567 (close)
Notable this week:
“We are off to the best month for the Dow since January 1987 —
interestingly, when it comes to that year, January is not the month most
people remember. Like back then, we have a very
expensive stock market on our hands that is hugely overextended
now that 90% of the S&P 500 members are trading above their respective
200-day moving averages — something we haven’t seen in over six years.
Short interest is back to a six-month low.
The bull camp is way too crowded, with positioning far too lopsided at the moment.
– David Rosenberg, Rosenberg Research, “Breakfast with Dave”
We note a couple changes to the signals in this week’s post. Ned Davis Research’s crowd sentiment and daily trading sentiment indicators are showing “excessive optimism,” which is generally short-term bearish for equity markets. Additionally, as shown in the chart below, fund flows into ETFs also indicate excessive optimism. Please note the S&P 500 Index performance (% gain/annum) in the data box at the bottom of the chart.
With regard to fixed income, the Zweig Bond Model moved to a buy signal, favoring high-grade corporates and long-term Treasurys. The CMG Managed High Yield Bond Program currently remains in a buy.
Posted this morning by Atom Finance, “[T]he market continues to brush aside the surging coronavirus cases in the U.S., and the corresponding business restrictions, on optimism that a vaccine and stimulus will revive the economy next year. This part of the bull market has seen new leadership from the cyclical, value, and small-cap stocks.”
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Click here for this week’s Trade Signals.
“Good mashed potato is one of the great luxuries of life.”
– Lindsey Bareham, Food Writer
Many people responded to my mention about Parkinson’s in last week’s OMR. There is some real promise out there. Please know I will get back to you soon. If you missed that note, here’s a link to it.
Our Marine, Tyler, is coming home for a month before he transfers to his new base in North Carolina. We learned last night he’s on COVID-19 quarantine, as one of his fellow soldiers had the virus. We are hopeful he gets the all-clear by Thanksgiving. Brianna is already here; Matt, Kyle, and Conner are coming back from Penn State; and our youngest, Kieran, is going to lose sole rule over the basement Xbox.
Daddy needs to stock up on the IPAs and reload the wine cellar. The young adults are coming home. Every other year, we host Thanksgiving at our house. This year, my kids are with their mom and Susan’s boys are with their dad. So, we’ll be having dinner together the night before. I’ll be manning the grill and I think we are going with steaks.
Last year’s dinner was great fun. Aunt Sunny Silver joined us, and she always comes with a surprise or two. When the kids were young, she brought over a dozen or so pictures of dinosaurs and taped them to the wall. She gathered us all in the room and to our surprise (and to the particular shock of the older kids), she broke into a rhythmic song that reviewed the names of each of the dinosaur that hung on the wall, in the order she had affixed them. She may have retired from the classroom, but she’s a teacher for life.
Last year, she brought the note card pictured below. The idea was to teach Susan and the kids some of the more common Yiddish sayings.
May you enjoy your “mishpooka” at your Thanksgiving “simchas” and experience great “freilich.” Wishing you and your family a wonderful Thanksgiving celebration.
Here’s a toast to you, your family and being together!
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
Click here to receive his free weekly e-letter.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
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