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Over the last few weeks we have received many questions asking how S&P 500 futures trading at night or early morning determine how the market will open. To help answer these questions and provide the calculation necessary to make sense of after hours trading we provide you with the following article. CLICK TO READ IT

April 9, 2020

Jobless Claims will be released at 8:30 this morning. The current estimate is for another 5 mm people to join the approximate 10mm of newly unemployed from the prior two weeks. Also of interest, PPI will be released today and CPI tomorrow. Both inflation figures are expected to be down by 0.3%, but like all other data, the results may stray far from expectations. Jerome Powell will speak at 10 am. We suspect he will remind us once again that the Fed will do whatever it takes to stimulate the economy and stabilize the markets.

OPEC will hold an emergency meeting at 10 am. The rumor is that they will announce an output reduction of up to 10 million barrels per day. Crude oil rose over 10% and stocks zoomed higher as the rumor circulated yesterday.

Stock and bond markets will be closed on Friday for Good Friday.

The Fed released its minutes from their March 2nd and March 15th emergency Fed meetings. We share a tweet from Wall Street Journal Fed reporter Nick Timiraos that sums up the Fed’s concerns- Wednesday’s FOMC minutes use the adverb “sharply” 18 times to describe changing economic and financial conditions. Some form of the word “deteriorate” and “severe” appears 14 and eight times, respectively.”

The VIX has steadily declined from over 75 to its current reading in the low 40s. While still very high, the reduced volatility is becoming more noticeable with daily and even hourly market gyrations having calmed down a bit.

We recently increased our exposure to gold and gold miners and bought a new position in STIP, a short term inflation-protected Treasury bond ETF. These additions are, in part, due to a growing concern we harbor that the Fed’s massive and unprecedented efforts to manage markets and minimize the economic impact of the virus will be inflationary when the economy normalizes. Because of this concern, we have been looking at commodity producers that may benefit from higher prices. In our opinion, it is still early to start buying but time to start making a shopping list. The graph below charts how various commodities have fared year to date.

April 8, 2020

Per the Mortgage Bankers Association (MBA), the percentage of mortgages not making payments (in forbearance) has risen from .25% to 2.66% as of April 1. Mark Zandi of Moody’s Analytics thinks that number could rise as high as 30%.

Moody’s recently published a list of B3 Negative and Lower (Junk or soon to be junk-rated) corporate debt ratings and it is now at its highest level. Currently, 311 companies are on the list, beating its prior peak of 291 companies from 2008 financial crisis.

Based on an FT article, dividend futures contracts imply that dividends will not return to 2019 levels until 2028. To put that into context, it only took three years for dividends to fully recover from the 2008 crisis, but nearly 20 years to get back to even after the Great Depression started.

As of Tuesday morning, Gold futures were trading about $25 above spot gold. In other words, gold purchased for settlement and delivery in the future is trading more than gold for current settlement and delivery. Such an anomaly has not occurred since 1979. This condition is very odd as banks, dealers, central banks, and investors can buy gold for spot settlement, sell the futures contract at the same time, and earn a rewarding risk-free return. The possible explanation is that physical gold is not available in enough size to obtain the risk free arbitrage.  If we learn more we will pass it on.

On a positive note, New York City has admitted less Corona Virus patients than they discharged for four straight days. Today’s Chart of the Day shows that many countries are experiencing a similar drop off in cases as they pass their peak. Tempering the good news, other big cities like Washington, Chicago, and Los Angeles are concerned that they are still ramping up to their peaks.

April 7, 2020

Stocks shot out of the gates on Sunday night, added to the gains throughout Monday and again through last night. Unlike the stock rallies of last week which were based on Saudi Arabia and Russia agreeing to production cuts, this one came with a deal looking less promising and oil trading lower. Bond yields are up slightly but not as much as one would have expected given the stock rally. Also of interest, the dollar was relatively flat and gold closed above $1700, reaching an eight year high.

The Fed created another new facility. This one offers financing to the banks and other investors that own the new small business loans (PPP) guaranteed by the SBA. This will enable the banks to borrow using the loans as collateral, which should allow them further liquidity to create new PPP loans. These loans are guaranteed by the SBA. At some point, the SBA will require a bailout as many of these loans will not be paid in full.  Fed Chair Powell will speak at 10 am on Thursday, presumably on a broad range of monetary policy and economic topics.

Rumors are circulating that a potential suspension or reduction of the long term capital gains tax is a possibility.

Since the market sell-off began in February, the S&P 500 has fallen nearly 900 points (through last Friday). The chart below shows that only 27% of the losses have occurred during the day trading hours, with 73% occurring during the futures overnight sessions. For most investors, the inability to manage risk during the more volatile overnight trading hours makes trading in this environment even more difficult.

The chart below shows that year to date, share prices of some of the nation’s largest department stores are down 65-75%. JC Penny (JCP) stock is trading at 27 cents a share and is on bankruptcy’s doorstep. It does not take a leap of faith to suspect that the others are not far behind if the shutdowns continue longer than are expected.

As we ponder the fate of these stores, there is an equally troubling problem to consider. Large department stores like the ones shown above are the cornerstones for malls. Through low interest rates, leverage, and insatiable investor demand for yield, shopping mall REIT’s like SPG, SKT, and TCO, developed what in hindsight may have been an excessive amount of mall square footage. Per Statista, the mall square footage per capita (23.5) in the U.S. is about 5x greater than the U.K., Italy, and Japan. The only two countries that come close to the U.S. are Canada (16.2) and Australia (11.8). Despite sharply discounted share prices, economically sensitive shopping mall REITs are leveraged and heavily reliant on shutdowns ending and a healthy consumer coming to the rescue. Needless to say, we urge extreme caution and be careful not to get fooled by double-digit dividend yields, as dividends will be reduced.

The calls for allowing the Fed the power to buy stocks got louder yesterday when Janet Yellen promoted the idea on CNBC. To wit:

“It would be a substantial change to allow the Federal Reserve to buy stock,” Yellen told CNBC’s Sara Eisen on “Squawk on the Street.” “I frankly don’t think it’s necessary at this point. I think intervention to support the credit markets is more important, but longer term it wouldn’t be a bad thing for Congress to reconsider the powers that the Fed has with respect to assets it can own.”

 

April 6, 2020

The employment report was much worse than expected as 701k jobs were lost and the unemployment rate rose to 4.4% from 3.9%.

Of the 701k  jobs lost, over half (417k) came from the restaurant industry. It is estimated that the industry employs over 15 million people, so unfortunately, Friday’s number may have just been the tip of the iceberg. The graph below puts the losses into context with prior recession experiences.

The data used for the Friday employment report was based on surveys up to March 12th. Bloomberg says that the early consensus for the April report, which will capture the rest of March and the full impact of the economic shutdown, is around -20mm with a 15% unemployment rate. As if that forecast was not bad enough, we need to factor in that many employees that still have jobs will have their hours and salaries reduced.

As we have mentioned, the value of the dollar can tell us a lot about the acuteness of the global dollar shortage. This past week the dollar index rose about 3% and with it concerns are rising about liquidity.

Crude oil rose sharply again on Friday as it appears Russia and Saudi Arabia are discussing production cuts. Assuming those two countries can agree, a deal may be contingent on some sort of reductions to U.S. supply. Given that the government does not control U.S. oil production, nor does the government own oil companies, this seems like a tall order. Further, many shale producers are independent and not owned by the majors. That said, given the dire situation, the big oil companies may be able to come to some agreement and appease Russian and Saudi requests.

Credit Suisse announced that its once-popular 3x leveraged inverse crude oil ETF (DWTIF), which was a victim of the sharp rally in oil the last few days, will be delisted as its value went to zero on Thursday. This ETF once had over $1 billion in assets. We suspect that the SEC will outlaw 3x leveraged ETFs as they cannot stand up to extreme volatility.  It would also not be surprising to see leveraged ETF’s also banned at some point.

Per The Numbers, the number one grossing movie on Thursday, March 19th was Disney’s Onward. It grossed $33,296. The Invisible Man came in second at $21,800. Since then, the situation has worsened. Total box office sales last week were only $5,179.

April 3, 2020

The number of new Jobless Claims for the past week was 6.6 million. To put that into perspective, the highest weekly claims number during the 2008 crisis was 665,000, and the total number of jobs lost during the crisis was about 9 million. Continuing claims from just last week and this week are now at 10 million.

Crude oil rose nearly 25% as China announced it would add oil to their reserves. Also helping the price are rumors that Russia and Saudi Arabia are discussing production cuts.

The Fed’s balance sheet for the week ending Wednesday increased by $586bn, which is about $30bn more than the entire QE2 operation which lasted about 8 months. Since March 4th it has risen by slightly over $1 trillion.

From April 1st through April 8th, the U.S. Treasury will issue $486 billion in new debt. Despite being only one week into April, that is half of the total for April 2019 and 75% of the issuance for all of April 2018. Stimulus spending and falling tax revenue have the potential to generate a $3-4 trillion deficit this year. There is no doubt that QE will be used to monetize this massive surge in debt.

The helpful table below from Bank America summarizes credit card spending by day and category. This is a good tool to help with stock/sector selection.

The following Tweet from David Schawel is very telling of the disillusion that many investors had going into this crisis. Over the last month, as shown below, the yield on Macy’s 4-year debt rose from 2.9% to 15%. David’s tweet and other messages of his imply that a 15% yield is too high. Instead, David should consider that the 2.9% yield that existed before the crisis was too low. Macy’s was slowly going out of business before the crisis hit. Their stock (M) fell from 52 in 2015 to 15 prior to the crisis, and it currently sits below 5. 15% is a fair yield for a company that has a good chance of filing for bankruptcy. Had Macy’s been properly priced at 8% or 10% before the crisis, the current yield would seem appropriate and may not be as shocking to most market participants.

Barbara Corcoran of CNBC’s Shark Tank was recently interviewed about the state of her small business investments. Of the over 70 small businesses/partnerships she is invested, she believes they have reduced staffing by 25-30%. More concerning, she stated that a majority of her investments will not survive. Further, all of her entrepreneurs are applying for Federal help and many of them are having trouble with the first step of the process, applying for help from the SBA. She did not seem optimistic Federal aid will help many of these companies.

April 2, 2020

The ADP Employment Report was lower by 27k jobs versus an estimated loss of 180k jobs. The report is clearly not capturing the bulk of the layoffs that have occurred over the last two weeks.

All economic data lags and some of it by up to a few months. Because of the delay, we and most other market participants are putting little stock in the current round economic data. In 2-3 weeks, corporations will begin posting Q1 results. The results will be mixed as January and February should have shown decent activity, especially for domestic companies. In most cases, we will look past the profits and losses and focus on forward guidance. Ideally, we would like to hear some optimism about a pickup of activity in Asia, as they are a month or two ahead of us in terms of dealing with the impact of the virus.

The table below shows the consensus of economist expectations for Friday’s March BLS Employment Report. Our model estimates a loss of 56k jobs. Because of current circumstances, we have no faith in our model’s predictive ability. For what its worth, Citi is predicting job losses of 10mm in the April report due out in early May. The worst monthly number during the Financial Crisis of 2008 was -800k jobs.

Financials, Real-Estate, and Utilities were the worst performing sectors yesterday as they are credit intensive industries, and despite the Fed’s efforts, there remains a lot of stress in the credit markets.

UK and European banks are canceling and/or deferring all dividends and buybacks, with some minor exceptions. Are the U.S. banks next?  While many smaller banks may take those necessary steps, we believe the larger banks will stop buybacks, if they haven’t already, but will try to keep dividends intact. European banks started the crisis in a much worse financial situation, so their actions may not reflect on the domestic banks. We also think that dividends signal financial health, and in times like today they care dearly about appearances. Also consider, the Fed will do whatever it takes to avoid bank failures.

April 1, 2020

Macy’s recently furloughed 125k workers, and The Gap and Kohl’s furloughed about 80k workers each. These actions are in line with similar measures from many large retailers. At 8 am this morning, ADP will release their employment report. There is no estimate at this time. Jobless Claims will follow on Thursday (est. 4mm vs. 3.28mm last week), and the BLS jobs report on Friday. Currently, we cannot find a BLS payrolls estimate, but we will share one if we do.

It is worth noting that when an employee is laid off, they receive COBRA insurance, but in most cases will have to pay the full health insurance premium and not just the co-pay. As if losing income is not bad enough, healthcare will be an additional financial burden on many households. These and other mounting financial problems for individuals is one reason we sold Visa (V) yesterday. Unless jobs are recovered quickly, or stimulus is increased rapidly, the discretionary and financial sectors will disproportionately suffer.

The Fed has been very aggressive in their purchases of mortgage-backed securities (MBS). Over the past week, the spread, or yield difference, between MBS and comparable maturity U.S. Treasuries has shrunk from 2% to just 0.67%, which puts current coupon MBS at or near the lowest spread ever. While this is undoubtedly welcome news for those looking to refinance or buy a new home, the fact of the matter is that in many cases, the individuals’ employment situation or outlook may likely preclude them from taking either action.

The graph below shows BBB-rated corporate yields on a nominal basis (green) as well as a spread to U.S. Treasuries (black). Note that nominal yields have only risen to the prior peak levels of the post-2008 era. The spread to Treasuries is higher, having eclipsed peaks over the past decade, but it is still well below the levels of 2008.  One possible takeaway is that corporate yields and spreads can increase a good amount more. That view, however, should be tempered by the fact that the Fed can actively buy corporate bonds, an action they were never able to do in the past.