I'll be brief. We have a lot to cover. It was not until Ulysses S. Grant ascended to the operational level of command that the war started to change. For once in command of operations, it is then that the tactical (micro) can be married to the strategic (macro), in order to enforce will (outcome) upon an enemy or a situation. Gone were the days of "winter quarters," the under-supplied Army of Northern Virginia would now have to fight. Constantly. Tired, hungry and shoeless. They would also have to worry about their homes.
As William Tecumseh took command of the Army of the Tennessee, and marched that army across the Confederacy, the concept of "Total War" was born, as the U.S. Navy had effectively put a stranglehold on what could get in and out of what was left of a shrinking independent south. Ever hear of the Soviet military doctrine of overkill? Perhaps those who created it were simply students of U.S. history. For it was U.S. Grant who created the very concept. Overkill. Shock and awe. We know how to do this.
U.S. equities rallied on Tuesday. It felt good, but really that is just an emotional sense of relief. Markets failed to recover the lion's share of Monday's losses, and this Tuesday rally was really inspired by just two factors.
One... the expectation that Washington would commit to some kind of fiscal stimulus plan in order to cushion a now struggling U.S. economy.
Two... the result of the past had placed a high probability of a rally of at least 2.2% on the S&P 500 on Tuesday. The index gained just less than 5% after bottoming at the precise spot (2734) where Monday's melt-down had also stopped. This spot also just happens to be almost precisely a 61.8% Fibonacci retracement of the S&P 500's December 2018 through February 2020 rally.
Now zoom in and take a look:
Algorithms can read. That should not surprise you. I have told you before that artificial intelligence will be mankind's last great invention. After that, we compete with something smarter, faster and tireless for resources.
Asian markets and U.S. equity futures sold off hard while we rested. Why? The virus continues to expand its perch above society, staring at, and choosing its prey by careful selection, or does the virus simply take as opportunity presents? Viruses are not considered living things, but they are considered to be alive. For if a virus is alive, then it is in competition for resources as well. Know thine enemy. There had been mention from the administration on Monday of something major on Tuesday. Tuesday passed quietly as news stories circulated that the president had pushed for payroll tax relief and that the idea had not been met with enthusiasm in congress.
Then European markets rallied, and U.S. equity futures found footing. Why? The Bank of England had announced an emergency 50 basis point reduction to the Bank rRate, cutting the benchmark down to 0.25% in response to the economic impact of Covid-19 upon the UK. The BOE also announced a Term Funding plan that would make use of reserves held at the central bank to help small to medium sized businesses get through this era of uncertainty. This comes one day ahead of an ECB policy meeting.
All good? Not really. The Saudis jumped in. Again. Apparently, state-owned Saudi Aramco has received a directive from the powers that be, to up output capacity to 13M bpd from 12M bpd. Remember on Monday? When we talked about the possibility of the Saudis taking production above 11M bpd. Well, they certainly are preparing to.
Mother Goose tells us that grace is followed by woe. But now it's Wednesday. Good morning. I hope you're fired up. I expect the volatility in financial markets to continue on until there is clarity. Either warmer weather dries out the spread of this virus, or the draconian measures of social distancing (either voluntary or enforced) do. One approaches quickly and releases pent up demand. The other takes far more time and does lasting damage. Understand?
Remember the whole concept of Complexity Theory that we have batted around in the past. The current condition of not just the economy or financial markets, but of daily life, is now quickly becoming far more complex. This does not yet come close to testing the theory. Financial systems are operating as designed. The nation's healthcare networks appear to fear possibly becoming overwhelmed, but this is not today's reality. We will know more, perhaps very soon. Some say that the United States is a week to 10 days behind Italy. Right now, that seems absurd. I am sure the concept of shutting down an entire G-7 nation seemed absurd to Italian leadership just days ago.
Put/call ratios remain elevated. The most important Treasury yield spread remains positive, and the thirty year bond now pays well more than 1%. That said, the nadir of the curve still runs between one year and two years, and this suggests a lack of economic growth for that period, not to mention a lack of consumer level inflation. This brings us to the point where aggression on behalf of policy makers (not usually really the aggressive type) becomes quite possibly necessary.
Situation.... Economic disruption. A supply shock hits manufacturers. Finished goods become scarce. Social distancing creates a demand shock unlike anything in recent memory. This social distancing then turns into an exacerbated dearth of supply... across the service sector. This is a service sector driven economy. Now what if supplies of medicines and services across the healthcare sector get hit? No answer. The nation may be facing rising unemployment and increased bankruptcies within weeks.
This is when the very idea that complex systems could become either adaptive or competitive will be tested. Economic unknowns... How deep? How long? What shape? (A vee, a ewe, or a hockey stick?)
Mission.... Overwhelm expected economic decline through sheer aggression. The time to worry about appropriate monetary policy and fiscal discipline was yesterday. Now, don't get me wrong. I have long been a proponent of executing these policies correctly. Proper financial discipline has long been ignored by successive Federal Reserve Banks, as well as successive administrations for political purposes. This should be a fight, but not today's fight. Right now, we have an enemy...
...and this enemy must be dealt with.
Execution... The Fed does seem to be on the ball of late, having greased the wheels of liquidity through an emergency 50 bps reduction to the Fed Funds Rate in between policy meetings, as well as increasing short-term repurchase operations (both overnight and 14 day). This is crucial as a liquidity crunch must be avoided.
Fed Fund futures markets trading in Chicago are now pricing in another 75 bps worth of reductions for the March 18 meeting. The FOMC probably needs to follow through on at least 50bps of this, while indicating a willingness to implement a vigorous round of quantitative easing. That said, I believe that the Fed should leave the long end of the curve alone, as we have learned over time that downward pressure on long-term interest rates causes more harm than good. The Fed's appetite will have to focus on the shorter end of the Treasury curve, and perhaps if it fits in the box of "maximum sustained employment" some distressed corporate debt though this probably requires congressional approval. Actually it does.
The administration, through the U.S. Treasury, must find a way to create a payroll tax holiday. Note to congress... get off your tail and get this done. Beyond that, testing for the Covid-19 must be widespread and the expense can not be an issue for any individual with a reason to test to delay being tested. Hourly wage, gig economy and self-employed workers who should be quarantined, but feel financial pressure to keep working, must be backstopped. If truly ill or quarantined, there must be a facility created the day before yesterday to operate alongside unemployment insurance claims. This is a biological and economic crisis. Time to act like it. If we're lucky, we cut this thing off at the pass, and everyone thinks we over-reacted. Heat like that would be welcome.
Oh, lastly, see what the Bank of England did? Low interest bridge loans are going to have to be offered to small to medium sized businesses in order to sustain employment.
Administration and Logistics... The SEC does not get out of this without a mention. It has gone way past imperative that the short sale uptick rule be re-implemented. It would help if minimum pricing increments at the major equity exchanges might be increased from one penny (or fractions of pennies) to one nickel. We traded in eighths people. We know that forcing short sales to be taken on a plus tick will slow down speculation, and I think we know that by forcing that purchase up five cents will remove high frequency overshoot on highly volatile days. This, in turn creates a higher level of public trust in the marketplace.
I think it common sense that a thoughtful, developed form of price discovery at some point replace whatever this has become. You all know, we did have physical places known as centralized points of sale. Every order had to be represented audibly at auction, and there was complete transparency. Name and number. Don't identify yourself.. you're not part of the auction. Equal footing. Common sense. Imagine.
Command & Signal.... When I say move, you will move. Now, move. This goes out to the administration, congress, the Fed, the U.S. Treasury, and the necessary regulatory authorities. I know this is simplified and you'll need to put your stamp on all of this, but the blueprints are here. You can be aggressive in the face of the unwelcome, or you can shrug your shoulders, look at the ground and wait for someone else. What's it gonna be?
Many folks have added Netflix to their "stay at home" portfolio, or their "virus" portfolios. I have created such pointed portfolios in response to the current environment. Readers are familiar with my "Rebound" play, my "Virus" play, and my "Revenue" play. I have tinkered with all three. So far the Virus group is doing the best, thanks to Clorox (CLX) and Teledoc (TDOC) .
One name that I have never included in any of these groups has been Netflix. I have thought about it, but had decided against. Perhaps that's why the note penned by Needham's Laura Martin caught my eye on Tuesday, a day that saw shares of NFLX spike after a couple of tough weeks. Martin does not think that Netflix benefits from the spread of Covid-19. In fact, she thinks Netflix could suffer due to the impacts of the virus.
Martin states that in the short run, even if folks watch a lot more streaming entertainment, that does not benefit Netflix directly as the firm charges a flat rate for the service. Martin also says that should the economic impact of this virus become severe, or prolonged, that folks may cut luxuries as incomes slow, and Netflix would certainly be a luxury. Lastly, she mentions the fact that Netflix debt is junk bond rated, and that the firm with its negative free cash flows relies upon access to debt markets. Interesting note. Worth looking up.
Economics (All Times Eastern)
08:30 - CPI (Feb): Expecting 2.3% y/y, Last 2.5% y/y.
08:30 - Core CPI (Feb): Expecting 2.3% y/y, Last 2.3% y/y.
10:30 - Oil Inventories (Weekly): Last +785K.
10:30 - Gasoline Stocks (Weekly): Last -4.34M.
13:00 - Ten Year Note Auction: $24B.
14:00 - Federal Budget Statement (Feb): Last $-33B.
The Fed (All Times Eastern)
Fed Blackout Period March 7-19.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (LK) (-0.13)