• Is there a way out of the Covid-19 crisis?

    I noticed that my last weekly comment was written on February 10 (already two months ago) and it was about the possibility to see economies stalling:

    Will economies stall due to a spread of quarantines?
    http://www.effectivevolume.com/conte...bruary-10-2019

    Today's comment is about the possible evolution of this crisis. It is about Central Banks and Government actions for preventing a total economic collapse. It is about resilience and how we will together get out of this crisis.

    I could write about the different Government's heavy interventions aimed at fixing the crisis through a total economy shutdown combined to a heavy round of corporate/private subsidies (helicopter money.)
    Central Banks have also heavily stepped in to lower interest rates and provide liquidity.

    As a whole, this means that we as societies are using a general industrial fabric designed to support thriving economies in a global environment in order to manage a new emergency situation only aiming at individual and economic survival. In the back of this, is the hope for a quick return of growth.

    Even though interventions are unprecedented and very large, still they are small compared to the size of the markets and economies that need to be protected. Just as a reference, below is the size of the US bonds market as of 2019. We can see that the liquidity provided to stabilize the different sections of this market is still relatively small. In other words, it is all about emergency short-term band aids that we hope will keep the blood from flowing out.



    Many (me included) have made a parallel between the evolution of the health situation and the evolution of the stock market. The quicker we fix the virus, the faster we will be back to the original debt fuelled growth pattern.

    I was myself rather sure that the Hydroxychloroquine based medicine would quickly bring an end to the crisis. I believed that it was just a matter of collective organisation.

    This is indeed what I wrote on my March 23 comment
    http://www.effectivevolume.com/conte...-March-23-2020



    We can see below that the market quickly understood that the crisis would be short-lived and indeed bounced on March 23.



    However, a few days later, I started to doubt my own analysis, simply because the Hydroxychloroquine that started to be prescribed in Belgian hospitals from March 16, did not seem to lower the ratio of patients moving into ICU. The following Table was posted I believe on March 26.



    Below is the same Table updated as of April 11. This table still shows an identical 20% ratio of ICU patients to hospitalized patients. It was also confirmed yesterday on national TV that this drug does not work as a final solution to the Covid-19 the same way that the tri-therapy drug worked to fix the HIV viral infection. In other words: we are not out of the woods and I now doubt very much that the virus will be fixed before we have a vaccine by 2021.



    We are now talking about a progressive end of the lock-down in Belgium starting by mid-May. This means that a lot of economic damage will continue to be experienced.

    Below is an interesting article that tries to justify a booming stock market in the context of the unravelling crisis.

    https://www.nytimes.com/2020/04/10/u...mentsContainer

    It is also interesting to read the Article below that calculates the average analysts expected S&P500 earnings:

    https://www.factset.com/hubfs/Resour...ght_040920.pdf

    The table below shows the price expectations (at the end of 2020) compared to actual stock prices. I noticed the great disparity between the ten most optimistic expectations compared to the ten most pessimistic expectations. In general, we reach a bottom when pessimism is at its highest. The fact that we find cruise boats and airliners in the list of the most optimistic targets tells me that analysts have not applied common sense yet and still believe that the virus will be fixed in a matter of weeks.

    If the virus is indeed not fixed by a miracle drug, then social distancing will be the norm even as we come out of lockdown and cruising/airlines are the opposite of social distancing activities...



    By the way, on the basis of the most updated current analysts expectations, the average PE ratio of S&P500 companies has not really moved. I fully expect this number to shoot much higher.



    Let's not forget that in 2009, the markets found a footing with the PE ratio crossing over 100.



    But something different might occur this time.
    If I remember well, the 2009 bounce was triggered by a change of the MTM rule (Marked-to-Market) to a MTF rule (Marked-to-Fantasy). I suspect that this time, companies will use a new MTS rule (Marked-to-Subsidy) to evaluate earnings and solvability. Government secured borrowing will be capitalized and subsidies will come directly into earnings. This means that the next Quarter's earnings will be greatly altered in order to reflect the full hope that the situation is temporary.

    Conclusions:

    As the Hydroxychloroquine based miracle drugs will probably not offer a short-term solution, we will evolve to a new type of economy: the social distancing economy.

    This means:
    - More work from home
    - More delivery of products either at home or at specific locations and only at a mutually decided time.
    - The systematic issuance of clean health passports to get key people back into productive activities (hence the rush for masks and tests)

    This means a much slower economy in the coming months because we will only slowly get out of the social distancing economy. People will return to restaurants, but they will make sure to keep a distance. This means much reduced per square meter profitability. From now on, outdoor activities will be preferred to crowd gathering venues (Disney, Six flags, cinemas, sport venues, political or religious meetings.) However BBQ within families, neighbours and friends will become more popular.

    In such an environment, do-it-yourself shops will thrive, together with social media tools/services.

    The stock market today is pricing a quick return to normality.
    Nothing will be smooth: the return to normality will be very slow and the new normal will be different from the old normal. The most difficult for investors will be to try to forecast companies earnings. Accounting/reporting rules will be bent to help a smooth return to a situation before the crisis. Companies will also notice that they need to drastically restructure their operation if they want to survive. As investors we will witness a lot of discrepancies between what is being reported in the books and the unexpected consequences of the changes.

    For now, cash is king, even though cash is printed by all the central banks.
    I might however consider buying September puts.
    Comments 1 Comment
    1. ijava3's Avatar
      The recent rally off of local lows, in of itself, makes perfect sense. The market was grossly oversold. And, pension funds et al were facing the end of the quarter, heavily under-weighted in their allocations, as the grace of the monetary and fiscal gods fell upon them. Throw in some front-running billionaire assholes, add the obligatory fomo participants, and you have the perfect storm for a reflexive rally or an Ackman bottom.

      Investors pulled more than $60 billion from equity mutual funds and ETFs over the past week, and as equity fund investors pulled out, “smart money” hedgers rushed in. Latest COT data shows that hedgers were holding more than $23 billion worth of net long positions in major equity index futures. What essentially began as a CTA short covering rally has been driven much further by short term investors i.e., event driven and absolute return funds front running the FED in much the same way corporate bond ETFs were raced higher.

      Of course, the existential debate is whether this is a bear market rally or the bottom. It's one of those tautological arguments that only be answered in retrospect; but, it’s difficult to believe that there is actually bona fide optimism about the economy. Profits actually do matter; and earnings, most surely are going to collapse. However, in some circles this is being rationalized and viewed as a “look through” for the next quarter or 2.

      In other words, they are writing off the impending horrific numbers because this is an “engineered” shutdown, and not a classic recession. And, when the Fed begins to directly buy equities via SPY, the link between prices and fundamentals will be severed, and price discovery will be relegated to the ash heap. They are saying the risks are recognized and understood, and as a result they are somehow mitigated. The worst is over!

      I get what the optimists are saying. Howard Mark's echoed their sentiments.There are 2 kinds of risk that investors face, the risk of losing money and the risk of missing opportunity; and they are mutually exclusive. Stocks are relatively cheap NOW, and if the market were to go lower, they will be even cheaper. Buy some now, and if you're afforded the opportunity, buy some more at even lower prices. After all, its always worked in the past. What could go wrong now?

      Well for starters participants are doomed to repeating the same mistakes that got them into this mess in the first place i.e., passive strategies, miscalculation of portfolio/tail risk, insane leverage, and even more insane valuation excesses. And now, because of the origins of the pandemic were in China, protectionism and trade wars will only intensify. The knock on effects from the virus will be deep an long lasting, and while the Fed has always been directly coordinating with fiscal every day under the moniker of QE, they have now transitioned to full blown, permanent monetization of an ever growing, ginormous, government deficit. Again, what could go wrong there?