With the new coronavirus cases now growing faster outside of China, we’ll likely see the true multiplicative nature of the virus over the next several days.
With that in mind, given the disruption to the global economy that will come if we do indeed have a pandemic on our hands, expect plenty of government and central bank intervention.
We’ve already seen an arsenal of measures deployed in China. Overnight, the Hong Kong government stepped in with a stimulus package, which included giving each adult resident 10,000 Hong Kong dollars. And this morning, Germany signaled the likelihood of fiscal stimulus. That had global financial markets on better footing as we entered the U.S. session this morning.
But key markets still sit on critical levels, namely the U.S. interest rate market. The 10-year government bond yield continues to hang around record lows today. Why does that matter? As we discussed yesterday, a slide lower from here (below the 2012 and 2016 lows), would be very damaging to market, business and consumer confidence.
Let’s take a look at what happened to yields and stocks during the depths of the ebola panic back in 2014. The fear about the prospects for global health were much the same as we’re seeing now. Here’s how rates and stocks responded (stocks fell about 10%).
As you can see, both had V-shaped moves, recovering before the peak in new weekly cases. In the chart below you can see the graphic of new weekly ebola cases back in 2014. The black box represents the period of decline in rates and stocks.
But clearly, with the origin of the current virus in China, the world’s manufacturer, it has a very different impact (than did Ebola) on the global economic outlook (pandemic or not). That’s where intervention comes in. Historically, major turning points in markets are associated with some sort of intervention. At this point, signs of containment should be the first signal for a bottom in markets. From that point, tailwinds of global central bank and government stimulus would serve as rocket fuel for markets. The “when” and “if”, on containment, are the big variables.
We talked yesterday about the message from the interest rate market. The past two times we were here, at record lows, there was a fear of the unknown outcome for the global economy – i.e. a fear of an impending implosion of the global economy.
This means rates at a very key level. And, already, after just a couple of days of declines in stocks, we are sitting on key levels in stocks.
Let's take a look at some charts …
Today, in the face of another plunge in stocks, the 10-year yield held pretty solid, but did indeed break to new record lows, before recovering into the close. You can see the triple bottom in rates here. Interestingly, though much of the contagion fear on the coronavirus over the past two days has been directed toward an outbreak in Europe/Italy, German yields are still about 20 basis points above the record lows.
As for stocks, the S&P 500 traded into big trend line support (the yellow line) that dates back the December 2018 lows.
As for the Dow, it’s now trading below the 200-day moving average (the purple line).
For stocks this puts us 7.8% off of the highs in the S&P, and 8.4% off of the highs in the Dow.
These technical levels will be key to watch tomorrow, but the most important market to watch will be the 10-year yield. A break down in yields from here would quickly bring about the negative-rates narrative for the U.S. And that would bring out the deflationary, secular stagation pontificators. That chatter would not be good for consumer and business confidence. And confidence has been a key piece in the economic growth formula.
As we've discussed, expect global policymakers to start signaling measures to offset drags on the global economy (from supply chain disruptions, etc.).
On Friday we talked about the drivers of the move in gold. Among the scenarios, we talked about the low probability scenario of the coronavirus turning into a global pandemic.
Today, that scenario continued to fuel gold and global government bond prices. And the fears of the low probability scenario becoming a higher probability scenario hit the equity markets today.
Now, a thousand point decline on the Dow doesn’t carry the significance that it would have ten years ago, given the value of the index (near 30k a week ago). But it’s still an eye opener and a headline event.
The last time we had a 1,000 point decline in the Dow was a little more than two years ago. For perspective, the concern at that time was inflation! In fact, it was fear that the bond market was telling us that inflation and interest rates were about to reset (higher!). The 10-year bond yield was trading at 2.88% at that time.
Conversely, today we have a 10-year bond yield that is testing the all-time lows.
As you can see in the chart above, the last two times we’ve been here in yields, it was on the fear of theunknown outcome (for the global economy).
In each of the prior cases, global central banks responded. Draghi effectively said, the ECB won’t let Italy and Spain default — he did the unimaginable by becoming the buyer of Spanish and Italian government bonds of last resort. And all major central banks were standing “ready to act” when the surprise Brexit vote hit in June of 2016.
The interesting thing about both the European sovereign debt crisis and Brexit is that the biggest risk that was being priced into markets was contagion (i.e. a spread of defaults, or a spread of countries opting out of the EU).
What is the risk of the coronavirus? Contagion.
With that, we have an unknown outcome from a human welfare perspective. And if we listen to those with the information and expertise, all we can do is trust that global pandemic is low risk. In a couple of weeks, we’ll know if global cases are growing by the same multiple as they’ve grown in the first month in China.
But we have a known outcome for the economy and markets. That is, global policymakers, in coordination, will throw anything and everything at it, if necessary, to keep the confidence intact, to keep markets afloat and to keep the global economy moving.
As we end the week, money is aggressively moving into gold, likely driven by Chinese demand (remember, they injected a quarter of a trillion dollars into the Chinese financial system earlier this month). Likely following that money, is speculation.
Why are people speculating on higher gold prices? To hedge against three scenarios…
Here they are, from lowest probability to highest probability (in my view):
Scenario 1) – Gold is being bought for relative safety, as a hedge against the worst case outcome for the coronavirus (i.e. Pandemic).
Scenario 2) – Gold is a hedge against the inflation penalty that many believe is inevitable, following the quadrupling in size of global central bank balance sheets since 2007, and the recent return to balance sheet expansion.
Scenario 3) – Despite what may seem (on any given news day) like a scary outlook for the pandemic threat, the highest probability scenario for owning gold at this stage, is as a hedge against hotter than expected growth (by year end) that is accompanied by hotter than expected inflation (i.e. a return of inflation). Remember, we entered 2020 with the tailwinds of solid economic fundamentals, ultra-low rates, fiscal stimulus still working through the system, and resurgence of confidence following the clearance of the trade war hurdle. In this positive scenario for the economy, it’s fair to say that the Fed, in its current stance, is at risk of getting behind in the case of an upside inflation surprise. That would be positive for gold prices.
These three scenarios have varying probabilities, but all point the same direction — north for gold. On that note, we end the week with gold breaking out to seven year highs …
We've talked about the Chinese central bank effect on global markets.
Among the biggest winners since China became the backstop for global markets earlier this month: the beaten down areas of the European stock market.
With that, let's revisit an excerpt from my February 10th note, where we discussed the opportunities in Spanish and Italian stocks…
"With a quarter of a trillion dollars of Chinese money undoubtedly being put to work in global markets, let's take a look at some opportunities in European stocks.
Like U.S. stocks, German stocks are on (or near) record highs. But there are very compelling laggards in Europe. Italian stocks are well off of record highs, still 44% off of the pre-global financial crisis highs. And you see in the chart below, the FTSE MIB traded today to the highest level since October of 2008.
Next, here's a look at Spanish stocks. It looks like a big breakout may be underway here too, with a break and three closes above this big trendline. This line comes in from the 2007 highs. Spanish stocks remain 38% off of those highs.
These markets have indeed been among the biggest winners for the month, and these technical lines have given way, as you can see in the updated charts below …
This continues to look like a huge opportunity to be buying the laggards in European stocks (Spain and Italy)… but only if the euro holds up.
This is a huge moment for the history of the euro. A break of this 20-year support would be ugly and bring about discussions of a return to the all-time lows. And that would likely be accompanied by draconian scenarios for the euro zone and the survival of the euro.
We had another new record high for the S&P 500 today, and global markets in general were predominantly “green across the screen,” led again by commodities.
The Chinese liquidity boom continues to float all boats. And it’s probably very early on.
Below is a look at the performance of global financial markets since the PBOC rolled out the bazooka of policy measures to open the month — in an effort to counter the drag on the global economy, from a lockdown of the world’s second largest economy (China).
The performance in the above table is just from the opening of this month! Essentially, everything is up, except bonds (relatively flat) and foreign currencies. Money is flooding into dollars and dollar-denominated assets (commodities).
Remember, it was at the depths of the global financial crisis, that China came in on a buying spree of beaten-down global commodities. Is this a repeat?
Here’s what they did to crude oil during that period …
In early 2009, it looked like global demand would never come back. China stepped in and began gobbling up cheap commodities. They ran oil prices back up to more than $100.
For markets, a threat like the coronavirus doesn’t have to go away for markets to move on from it. The worst case scenario (global pandemic) just has to be taken off of the table.
We’re not there yet. But as we’ve discussed over the past couple of weeks, for markets, the “unknown” about the coronavirus is being overwhelmed by the “known” of how central banks will respond.
If there is one thing we’ve learned from the events of the past decade, it’s that central banks will do, in coordination, “whatever it takes” to keep the global economy going, when faced with global crises.
In this case, central banks are responding, again, led by the PBOC.
Remember, as we’ve discussed, the elaborate measures taken by China earlier this month, to shore up the economy and financial markets, were a big deal, not just for Chinese markets but for global financial markets.
And with over a quarter of a trillion dollars injected into the Chinese financial system, we talked about the likelihood of that money being put to work, not only to stabilize global equity markets, but to start stockpiling cheap commodities again (as they did in 2010-2011).
With that, on a day where a decline in stocks were making headlines, commodities were on the rise. Palladium was up by 11%. Natural gas was up by 7%. Gold was up over 1%. Oil was up. And copper (a typical proxy on global economic sentiment) was up, not down.
With that, let’s take a look at a chart on the CRB index (the broad commodities index)…
You can see the path for broad commodities, since the PBOC rolled out their policy response (on Feb 3rd). The path has been UP.
Today was the deadline for all big money managers to give a public snapshot of their portfolios to the SEC (as they stood at the end of the fourth quarter). So let’s review why, if at all, the news you read about today regarding the moves of big investors, matters.
Remember, all investors that are managing more than $100 million are required to publicly disclose their holdings every quarter. They have 45 days from the end of the quarter to file that disclosure with the SEC. It’s called a form 13F.
First, it’s important to understand that some of the moves deduced from 13Ffilings can be as old as 135 days. Filings must be made 45 days after the previous quarter ends.
Now, there are literally thousands of investment managers that are required to report on a 13F. That means there are thousands of filings. And the difference in manager talent, strategies, portfolio sizes, motivations and investment mandates runs the gamut.
Although the media loves to run splashy headlines about who bought what and who sold what, to make you feel overconfident about what you own, scared about what you sold, anxious, envious or all a combination of it all, the truth is, most of the meaningful portfolio activity is already well known. Many times, if we’re talking about very large positions, they’ve already been reported in another filing with the SEC, called the 13D.
With this all in mind, there are nuggets to be found in 13Fs. Let’s revisit how to find them, and the take aways from the recent filings.
I only look at a tiny percentage of filings—just the investors that have long and proven track records, distinct approaches and who have concentrated portfolios. That narrows the universe dramatically.
Here’s what to look for:
1. Clustering in stocks and sectors by good hedge funds is bullish. Situations where good funds are doubling down on stocks is bullish. This all can provide good insight into the mindset of the biggest and best investors in the world, and can be a predictor of trends that have yet to materialize in the market’s eye.
2. For specialist investors (such as a technology focused hedge fund) I take note when they buy a new technology stock or double down on a technology stock. This is much more predictive than when a generalist investor, as an example, buys a technology stock or takes a macro bet.
3. The bigger the position relative to the size of their portfolio, the better. Concentrated positions show conviction. Conviction tends to result in a higher probability of success. Again, in most cases, we will see these first in the 13D filings.
4. New positions that are of large, but under 5%, are worthy of putting on the watch list. These positions can be an indicator that the investor is building a position that will soon be a “controlling stake.”
5. Trimming of positions is generally not predictive unless a hedge fund or billionaire cuts by a substantial amount, or cuts below 5% (which we will see first in 13D filings). Funds also tend to trim losers into the fourth quarter for tax loss benefits, and then they buy them back early the following year.
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Let’s step back from the day to day noise of newswires, and journalist opinions on infectious disease, and revisit what is an exciting outlook for stocks and the economy.
Remember, along the way last year, we were looking for a repeat of 1995, where the Fed was forced to reverse course on interest rates. We got it. And we got a big outcome for stocks.
And with that flip-flop by the Fed, we’ve talked about the prospects of seeing another big late 90s-type of run for stocks and the economy. After the Fed cut rates in July of 1995, the economy went on to average 4.5% quarterly annualized growth through the end of the 90s. Stocks were up big every year through 1999, with an annual average return of 26%.
Remember, we never had the big bounce back in growth, following the Great Recession. Historically, significant economic downturns are followed by a big bounce back in growth. For the 10-years following the Great Recession, the economy has grown at right around 2% annualized. That weak recovery has left the U.S. economy about $4 trillion smaller than it would be had we returned to the path of long-term trend growth (3%). This outlook of another late 90s boom would be a needed “catch up” for the U.S. economy.
So, with this in mind, we are in the midst of the longest economic expansion on record. As Bernanke has said, “economic expansions don’t die of old age, they tend to be murdered.” The Fed kills them through aggressive tightening, in fear of getting behind on inflation.
The good news. That seems unlikely this time around. For the Fed’s part, Powell has made it clear that there will be no rate hikes until it sees significant and sustained inflation above its 2% target. That should be the formula for a boom period.
Jerome Powell just spent two days on Capitol Hill, making prepared remarks to Congress on the economy, and then painfully entertaining their questions/ monologues.
The message from Powell hasn't changed. The economy is good and inflation is tame, yet they stand ready to act against changes to that view.
What could change that view? The old risk to that view was an indefinite trade war. The new risk to that view is the unknown outcome of the coronavirus. But the former already forced the Fed and the ECB back into balance sheet expansion. And the latter has the central bank in China flooding China, and global markets, with liquidity.
If we think about the primary purpose of this liquidity deluge: It's to stabilize and/or restore confidence. Confidence is the key ingredient in keeping the economic engine going. Through low rates, balance sheet expansion, and credit creation, the Fed has proven over the past decade to be able to promote higher stock prices and higher housing prices. That has translated into hiring, spending and investing, which has translated into economic activity — all despite a myriad of threatening crises.
So, currently we have record high stocks, a strong housing market, and solid economic data. It appears that the central banks (led by the Fed) have again been successful in using the balance sheet to stabilize confidence (which was waning in the third quarter last year).
This should be a powerful line of defense against a reduction in global growth from the health crisis in China. Still, the market is pricing in more Fed rate cuts – a coin flips chance of at least one rate cut by July. And by the end of the year, the market is pricing in a near 80% chance of at least one cut – and plenty of bets are being place on several cuts.
This is either reflecting the view of the coronavirus turning into a global pandemic, which would be far too conservative in pricing in just a rate cut or two. Or it's reflecting a view that the U.S. economy isn't any better today, than it has been over the past decade. Both seem like very low probability scenarios (unsupported by the data).
What's clear is that the market is leaning heavily one way. If this health crisis threat were to clear in the coming weeks, the economy would be positioned for a big upside surprise in growth into the end of the year. This brings in the other side of what could change the Fed's view: hotter inflation. That's my bet.
