From the depths of despair on Monday morning, when predictions of all sorts of Great-Depression-era returns engulfed the press and media, to Thursday morning, after a 17% rally in the S&P 500 from the lows, we are now hearing the same so-called pundits declare a bottom is in place. Investor emails are pouring in to ask, "did we miss it?" Arguably social distancing and self-quarantine leaves us with no choice but to stare at our news channels, but it is best to socially distance oneself from all this noise and generic market comments.
Human beings are driven by greed and emotion, so fickle, that one wonders how fickle their investment decisions would be. The markets have fallen 35%+ from the highs, and we have rallied nearly 20% off of the lows. Most investors expect a V-shaped recovery, but the problem we are facing is an ever-growing dynamic one -- one that evolves day by day depending on the severity and duration of the shutdown impacting the economy. How is the Fed's static solution going to magically quell the greatest crisis ever to unfold?
Bear markets are notorious for nasty rallies. They are called nasty for a reason, as they can be fast, violent and vicious, taking one's emotions and sanity on a roller coaster. The markets are driven by a combination of technicals, fundamentals and liquidity. The players have changed over the years as algorithmic/machine-driven strategies supersede the traditional flow.
Of course, technicals can only give us a clue as to where the potential pitstops are in the market. Fundamentals are the light in this ecosystem that dictate whether we can breach those levels on the upside or downside, if the news flow and situation deems it. After three weeks of relentless selling, we hit the all-time lows of 2180, which was coincidentally also the very important level where the November 2016 Trump election rally began.
With the Fed announcing bazooka liquidity measures, especially the last that allowed it to start buying actual corporate bond ETFs and other risky asset instruments, in a short window of time as selling took a breather, it allowed the market to rally back to the next level of resistance of around 2600. But now what?
From the week of March 19-25, the Fed has purchased $587 billion in securities ($375 billion in Treasuries, $212 billion in mortgage-backed securities), amounting to 2.7% of the $21.4 trillion U.S. GDP. As of Wednesday, the Fed's balance sheet has risen by $650 billion, taking it to $5.3 trillion, an increase of $1.2 trillion in the past two weeks (that is 5.6% of U.S. GDP).
As the Fed prints money like its toilet paper, how much is enough? Most central banks and foreign institutions have been selling U.S. Treasuries for years now, it seems slowly the Fed may be the buyer of last resort, monetizing the entire U.S. debt with no private sector being able to or wanting to own it. Not a healthy global reserve currency status, I have to say.
Crises such as these do not get resolved overnight, despite the Fed ballooning their liquidity injection day after day, hoping that one of them pans out and convinces the market that it is big enough to instil confidence. They seem to be on a trial and error path, and that is worrying, quite frankly.
The amount of distressed debt in the U.S. has quadrupled in less than a week to nearly $1 trillion, levels not seen even in 2008. Most of the distressed debt comes from U.S. energy companies -- as Saudis flooding the market with oil is another systemic problem outside of the Coronavirus demand shock, amounting to $161 billion of distressed debt, up from $128 billion a week ago. There are other multiple sectors facing the same crisis. If the Coronavirus shutdown does not end or the virus is not contained, every day will cause more and more losses for these industries as their debt is already trading around $0.60-$0.70 on the dollar.
This week, there are calls for U.S. to speak with Saudi Arabia to end their price war with Russia. Of course, the entire purpose of the strategy was for Saudi Arabia to grab more market share and sell more oil even at lower prices to make more revenue. Needless to say, even the Saudis did not expect oil to fall this much, it would be entirely futile on their part to now come back to table and suggest a cut or cooperation of some sort.
The U.S. is desperate and Trump can no longer bully his allies. Unless the entire U.S. shale market becomes part of a cartel that is told how much and when to produce, which will never happen as the U.S. is a free economy, why would Saudis cut now and revive the U.S. shale sector as they will stop their aggressive capex cuts as soon as WTI goes above $45/bbl? We are just starting to see aggressive capex cuts of 20%-25% across the oil majors and producers, the plan will take time to pan out but could actually end up helping oil recover later but more sustainably.
At $27 Brent, Russian oil producers, allowing for a discount of $10/bbl, are getting only $19-$20, which is economically unfeasible for them to produce unless they lash capex by 50%+ or shut down. These prices are not sustainable, but they have to stay here sub $35/bbl Brent to force these shut downs, so that all the inventory is soaked up. Only then can it move upwards.
Thanks to month-end pension rebalancing flows of $850 billion this week and after the negative quadruple-expiry that took a lot of the negative gamma with it, it allows the market to have a huge dead cat bounce from 2180 and target its next Fibonacci resistance around 2600.
For a market to truly make a bottom, it needs to retest its lows of 2180-2200 before moving sustainably higher. We are still in the eye of the storm. However, if the pain in the corporate and sovereign world gets worse, dare I say it, we can even make newer lows.
