2020-03-23

What a pump

Hi, been a little bit.

  • I talk about the Fed’s recent actions to backstop small-medium businesses,

  • my positioning,

  • and why buying back in right now is crazy because we might end up like Japan.

Since we last spoke, the Fed has introduced some unprecedented tools to make sure that corporates remain upright. It will start buying commercial mortgage-backed securities (presumably in anticipation of small-to-mid sized businesses missing rent payments) and investment-grade bonds to ensure that corporate credit is backstopped, even going to the extent of buying ETFs containing IG bonds.

But apparently the equities market isn’t buying it.

A bearhaus lieutenant who works in corporate bonds says the investment-grade credit market is looking much better than it was last week, but I don’t think this will necessarily translate into equities, and I think it’s particularly bearish that a pump of this magnitude (and, frankly, novelty) hasn’t netted the S&P anything since it was introduced.

Fundamentals remain incredibly bleak. What looks like an exponential growth of covid cases is in the early stages of unfolding in NYC, the national guard has been deployed to three states, and US jobless claims are projected to blow out to historical measures.

What does Uncle Sam have left on the table? Obviously fiscal, though I’m thinking this will be a too-little-too-late situation.

The Fed could also surprise markets at some point by contorting itself into buying equities, either outright or through some vehicle as with the commercial paper trick: Fed sets up a corporation, or a “Special Purpose Vehicle” (SPV); SPV takes commercial paper and soon muni bonds as loan collateral.

The CPFF2020 will be structured as a credit facility to a special purpose vehicle (SPV) authorized under section 13(3) of the Federal Reserve Act. The SPV will serve as a funding backstop to facilitate the issuance of term commercial paper by eligible issuers.

The Federal Reserve Bank of New York will commit to lend to the SPV on a recourse basis. The New York Fed will be secured by all the assets of the SPV. The U.S. Treasury Department—using the Exchange Stabilization Fund (ESF)--will provide $10 billion of credit protection to the FRBNY in connection with the CPFF.

- Fed doc

Anyway, here’s a quick update on my positioning and general thoughts on the market.

Positioning

Still long $SPY puts, still doing quick shorting of S&P futures (selling into most rallies). I went short into last weekend since, as far as I can tell, fear and an understanding of the very real economic collapse only gets more pervasive while markets are closed. The only other position I’m holding onto at the moment are puts on $HYG, which appear to be unaffected by the Fed’s promised buying spree.

Long-term, I have smallish positions in physical gold and Bitcoin, both of which I expect will sell off in concordance with equities in the short-term. Everything else is cash. Once we reach an apparent bottom in equities (which I reckon may take months), I’ll be looking to position with a 40/30/30 split of stocks/bitcoin/gold.

Anyone buying dips at this point is absolutely crazy IMO. This is shaping up to a very lengthy recovery and I think instead of having a V-shaped bottom as we’ve had in previous financial crises (2000, 2008), this one will be more L-shaped. Largely because this is not a crisis that is endogenous to financial markets, and can’t just be fixed using the usual liquidity mechanisms that the Fed has become so fond of over the past two decades. This is a real shock to the economy like we haven’t felt since WWII. I’m not a financial adviser and this isn’t advice but if you’re buying dips I think you are absolutely out of your gourd.

Why not buy back in now?

A friend asked recently “if buying a large equities index just mirrors a bet on the progress of human civilization, and we believe in that progress long-term, why not just buy back in now?”

This is a good question and deserves to be addressed. Setting aside the claim of the inevitability of long-term progress (ha-ha, gallows humor), my short answer is (i) high P/E ratios, buybacks, and leveraged-loan use by corporates means we’ve been pulling future cashflows forward for years, and that may not be possible anymore.

A digression on the value of equities

The reason that equities are valuable is because they are a claim on future cashflows for some company. You buy the stock and expect eventually to be rewarded in dividends or some other kind of yield.

If that company whose shares you bought has boosted their share price by taking out loans to buy back stock at low interest rates instead of investing in R&D or creating some kind of more tangible value. This means that if cheap money dries up, the share price might be stagnant for years because you’ve already pulled those price increases forward using leverage.

Part (ii) of the short answer is to take a look at Japan’s equity market.

30 years later, they still haven’t taken out the highs they hit in 1990. You’re still underwater if you bought the Nikkei 30 years ago. Don’t think that can’t happen to us.

Oh and by the way, the BoJ owns 77% of their ETF market. Sound like something we might be headed towards?

From Bloomberg

Keep your head on a swivel. Happy shorting.