March 2020 will certainly be a month that will be etched in people's minds forever. Vicious stock market collapses followed by face-ripping rallies, perhaps Shakespeare had it right, March is certainly a month to be wary of. Despite his ominous ramblings, March typically ties into a series of quarter end portfolio rebalances that can mask the true underlying picture of the economy as liquidity overtakes logic. Add on Hedge Funds facing a mother of all redemption quarters as they suffer between 5%-20% for the quarter in equities, bonds, and other multi-strategies, you can only imagine the disconnect in stocks and asset classes in the last weeks of March. After having witnessed the fastest market crash going back past 1920s, we have now witnessed the quickest rally in seven days as the S&P 500 moved up 18% from its lows touched last week. Incredible that those who were screaming depression a little over a week ago, are now suggesting a bottom is in place and given the Fed's endless largesse, the market has only one way to go, higher.
Let's take a look at some facts. As China is slowly returning from its horrendous February shutdown, irrespective of its PMI suggesting growth back at 52 vs. 35 in February, which seems utterly preposterous given the scale of the shutdown and time to slowly restart, the rest of Europe and U.S. are just now in the midst of the start of their full lockdown mode. They are perhaps a good month away from some sort of normalcy, not a return of peak demand. Even if the virus is contained, the next step of handling the pandemic can prove to be a bit more problematic than the shutdown. U.S. Q2 GDP is forecasted to be down 45% annualized, the single worst quarter in American history going back to the Great Depression or the Civil War.
The amount of measures taken by the Fed have been jaw dropping, especially as they managed to do more in four weeks what took 80 weeks during the Global Financial Crisis of 2008. Outside of being the lender of last resort to the U.S., the Fed has now become the central banker to the world. They are buying up to $600 billion a week in Treasuries, bonds and other securities, and opened foreign swap lines to other central banks. At this rate, the U.S. can print close to $30 trillion to guarantee the entire world; the budget deficit of $1 trillion will seem like child's play. The U.S. dollar will certainly be worth a lot less. One would imagine the amount of bonds the Fed is buying, rates would be closer to zero or negative, but they are not. It just goes to show how much flow is on the sell side of these bonds, after all, why would anyone want to own U.S. bonds now?
Back to equities. We made the case for a rally from the oversold levels of 2180 on back of negative gamma open interest expiring together with $850 billion of month end Pension Fund rebalancing. Given how extremely oversold the market was, a bounce was likely only to capture the next Fibonacci resistance around 2640, where the market is currently struggling to break through. A bull market does not form when equities move in 10% increments. They generally form when market slowly grinds higher day after day on low volatility. We are far from that.
Forgetting the S&P 500 at the index level, if one investigates further, there are some serious discrepancies. Utilities are outperforming Financials which would never be the case if the recovery was "healthy". The Small Caps Russell Index (IWM) is up about 15% from its lows vs. the large caps S&P 500 Index (SPY) which is up 25%. Smaller more levered stocks always outperform in a recovery.
The oil price is still hovering near its lows of $27/bbl. Brent and physical market is gushing with oil (no pun intended). They are running out of floating storage and pipes are full, so much so that the physical markets are suggesting lower prices to come. There is about $166 billion of debt soon to expire, with these prices it will strain the system and banks exposed to it even further. The VIX Index, typically a gauge of risk sentiment and uncertainty in the market, is still trading around the 50s, and not a level that suggests a healthy bull market. Last, but certainly not the least, the entire world is still short the U.S. dollar given the global debt amassed by all sovereigns and central banks. Every day that we are in lockdown, more and more countries and companies will face higher debt servicing costs and losses demanding them to buy even more dollars. The dollar has been rallying for the past few days, suggesting the infamous $12 trillion dollar margin call from JP Morgan (JPM) is far from over.
One of the most supportive factors for the market over the past year have been share buybacks. Companies have been artificially boosting their shares by borrowing cheap money from the Fed to buy back their stock, inflating their earnings. Financial engineering trickery. According to Goldman Sachs (GS) latest note, nearly 50 U.S. companies have now suspended existing share repurchase authorizations in the past two weeks ~ $190 billion of buybacks or nearly 25% of the entire 2019 total!
Given the scale of the selloff and mouth-watering levels, it is tempting and plays to our very human greed to step in and make out like a bandit. But we must remember how and where things were exactly seven days ago. We have not seen the worst of U.S. mutual fund redemptions, or individuals who need to call their 401k's. The stimulus bill is passed but it will be a little while before we see the actual payments being made. In the meantime, there will be more and more "dead bodies", for lack of a better word, before this episode is over. Going back to GFC, after Bear Stearns, everyone thought it was over but then a few months later the market was dealing with even more collapses like AIG (AIG) and Lehman. Despite the Fed's generous mortgage backed securities buying, the mortgage market is in a state of distress. They are sounding alarms to the Fed to call off their margin calls as these non-financial lenders generally issue new loans and short mortgage backed securities as a portfolio hedge. Now that the Fed is eating up the MBS, it is killing them both ways. There are already a few that are blowing up.
To quote someone very wise and perhaps a tad bit more mortal than Shakespeare, "The Fed has just put the economy in an induced coma, attaching it on fiscal and monetary life support, hoping that when the time passes it can be brought back to life". The only problem is, what if the patient undergoes cardiac arrest before then?