Why the Risk-Off Trade Isn't Over -- And What Gets Us to Risk-On

I recently sent around an old article, Lehman was NOT a Moment. I argue that Lehman was a process (the S&P 500 finished up the week that Lehman filed, which surprises many). In fact, Lehman was only part of a process that involved risk reduction and conservative behavior across the board -- much like we are seeing now with the coronavirus. I'm told this reaction to coronavirus is temporary, transitory and easily digestible. However, the reaction to the virus could have more impact than people realize. Too much uncertainty around the virus While there are many reasons not to be as afraid of coronavirus as we currently are, there is too much uncertainty to take that risk. The weakest could be pushed over the financial edge Large companies should have no problem dealing with the coronavirus quarantines for a month, or two or even a quarter or two, though the longer it lasts, the more people that will be impacted. But what about small service providers? Can you run a restaurant for long with no customers? People who depend on tourism or conferences for their business or livelihoods? How many car payments can an unemployed person make? As these people and companies struggle, the people who depend on them will also feel an impact. This will be a bottom-up problem and for some reason people seem to be ignoring that. I think that is a mistake that needs to be priced in. U.S. fear level has to catch up to the rest of the world I would argue that most people in Asia seem to be living with a 7 to 8 out of 10 level of concern about the virus. Supposedly it is now common in China to have your temperature taken 10 or more times a day (assuming you are in an area where travel is permitted). As cases ramp up in Italy, I see Europe as about a 6 or 7 and heading towards 8 or higher (travel restrictions are the antithesis of the EU but something they may have to deal with). As of now I would categorize the U.S. as being only at a 3 or 4, though it should rapidly approach 7, which will keep us in risk-off mode. Positioning is still wrong Buy the dip lives and breathes. That likely needs at least one more wipeout. If the S&P 500 can crack 2,900 that will take out any recent buy-the-dip gains (and probably trigger some selling from those who bought and from those who sold volatility thinking the worst was likely behind us). What Gets Us to Risk-On? I think right now there are two scenarios that get us to risk-on mode. 1. Clear evidence that we have over-reacted. This is what I think would make that clear. -- The mortality rate is low (in line with the flu for example) -- The mortality rate is heavily skewed toward the very elderly and those with pre-existing conditions (which may include heavy smoking). -- That as warm weather arrives, the cases in Italy and other areas drop (it may be what is helping Hong Kong and Singapore, though I'm not convinced that their data isn't affected by a lot of other influences, not least of which is an unwillingness to get tested because the act itself can land you in quarantine, etc.). 2. Fiscal stimulus, supply chain reclamation and aggressive lending programs. I would love to see support for those trying to repatriate supply chains. To see programs that make sure otherwise solvent people and companies are given the opportunity to weather the storm. This can happen in one of two ways: -- Congress and the president work together to deliver a real solution. I'm not sure I believe this is possible, but had to put it out there, as maybe D.C. will surprise us. -- Declaring a National Emergency. This sounds weird at first and would not be optimal like the option above but it has its merits and seems plausible. a) The president could remove those currently in charge and put himself directly in charge (he does like to take the lead and was slightly strange, at least to me, that he delegated the role). b) With a National Emergency, the president has access to funds without congressional approval. He takes over, and rides to the rescue with massive amounts of cash that is easier to get at than negotiating with Congress. c) The Fed can enact measures too. The Fed is already able to relax regulations for banks. They do that periodically (often around natural disasters). They can ease back on the implications banks face from having delinquent loans on their books. This is one way to mitigate the impact on the weakest borrowers. This is an evolving situation, but now you know why I'm remaining in risk-off mode and what I think would change my mind to shift to risk-on mode. Levels I have in mind are around 2,800 on the S&P 500, around 90 on CDX IG and 1.25% on 30-year Treasury (though I'd be willing to short Treasuries before buying stocks). Keep everything small and nimble because liquidity is abysmal.

Why the Risk-Off Trade Isn't Over -- And What Gets Us to Risk-On

Right now there are two scenarios that get us to risk-on mode.

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