June 4, 2020
As the May economic data begins to roll in, let’s update the picture on the damage to the economy.
Last week, we had the first revision of the Q1 economic output. It was down 5%. Of the twelve weeks measured, the economy went into lock down for the last three of those weeks. You can see that timeline here …
If we extrapolate the Q1 economic contraction to a full quarter under lockdown, maybe we get something in the neighborhood of -20- to -25%.
With that in mind, let’s revisit how the Atlanta Fed is projecting Q2. Remember, just three weeks ago, the Atanta Fed model was projecting -43% for Q2. Today, the model is projecting down 54%. You can see what the evolution of this projection looks like (the green line) as the Q2 economic data has been rolling in. It has continued to move lower.
What is the consensus view of economists outside of the Fed? The blue line shows the average forecast of a 35% contraction.
This continues to look like the expectations are set to be beaten (i.e. positive surprises).
The latest University of Michigan consumer surveys (sentiment, current conditions and expectations) all remain well above the levels of the Global Financial Crisis.
And “capacity utilization” was running at about 65% in the last report (from mid-May).
As we discussed last month, the important takeaway there, it’s not zero. Despite what is described as an “economic stoppage,” the economy still operated at almost 65% capacity in the month of April. And I suspect it will better in May, as economies began to open up as early as the last week of April.
So, what’s the disconnect in this data and in the Atlanta Fed model?
The models these economists rely on doesn’t account for the unprecedented actions taken by the Fed and Congress.
They have protected the balance sheets of consumers and businesses. That’s the difference.
And today we had good news on that front. The Senate passed revisions to the PPP loans. Small businesses will now have six months, instead of two months to spend the money that was intended to bridge them from closing to a full reopen. And they will now only need to use 60% of it toward payroll, instead of 75%. Translation: It has become a more balanced mix of payroll grants and a pure cash grant.
With that, small businesses that were in decent condition have survived, and in some cases are flush with cash, as the doors have reopened for business. Plus, employees have been kept whole, through a combination of subsidized unemployment and an attachment to their jobs.
This all sets up for a huge bounceback in the economy.
Remember, between fiscal and monetary stimulus, we have more than a quarter’s worth of GDP already pumped into the economy. That implies a complete stoppage of the economic heartbeat for three months. That hasn’t been the case – far from it. The excess money in the system is going to levitate the nominal value of GDP.
May 26, 2020
Stocks open the week with a surge above key psychological levels (over 25,000 in the Dow and over 3,000 in the S&P 500).
That’s 37% from the lows of March — thanks to the sea of liquidity (both fiscal and monetary stimulus) pumped by the Fed and the Treasury (via Congress).
Now, this 3,000 level in the S&P happens to be spot-on the 200-day moving average. We’ve been watching this big technical level for a while now. I suspect that this will continue to represent the top of the range for while, until we get a better picture of how consumer psychology looks in the the economic reopening.
From the media tone, it seems like the psychology of fear, that has gripped the country over the past two months, might be worse than the virus.
But that doesn’t sync with the April survey from the University of Michigan on consumer expectations. That report showed consumers considerably more optimistic than they were at the depths of the Global Financial Crisis.
So, is there a wide divide between how the consumer might behave as more businesses reopen, and how the media thinks they will (or should)? That wouldn’t be too surprising.
For our guide on the economic reopening, let’s revisit the key data on how the health crisis is tracking: With a month under the belt on state reopenings, we have no spike in cases, and importantly, a continued decline in deaths.
Add to this, last Wednesday the CDC’s published new, lower estimates on the severity of the disease. Of five scenarios, the “best guess” scenario showed a case fatality rate of 0.4%. The worst case scenario was 1% (of cases). And the best-case scenario would be a case fatality rate of 0.2% – a small fraction of what was originally projected. These are all dramatically more optimistic projections than we saw early in the crisis.
With the above in mind, this Memorial Day weekend may have represented the defining “rip the band-aid off” moment for the economic crisis.
If you are hunting for the right stocks to buy and need some help navigating the changing investing environment, join me in my Billionaire’s Portfolio. We have a roster of 20 billionaire-owned stocks that are positioned to be among the biggest winners as the market recovers.
May 22, 2020
As we head into the long holiday weekend, let’s take a look at a key chart.
In a world that has been gripped by fear, this chart plots the level of fear in the stock market (better known as the ‘fear index’).
The VIX tracks the implied volatility of the S&P 500. It’s not actual volatility, as might be measured by the dispersion of data from its mean. Implied vol has more to do with the level of certainty that market makers have or don’t have about the future.
When big money managers come calling for an option, to hedge against a potential decline in stocks, a market maker prices the option with some very objective inputs. But also with a very important subjective variable, called implied volatility. When uncertainty is rising, this implied volatility value rises, to include a very healthy (sometimes absurdly high) premium over actual volatility.
To put it simply, if you are an options market maker, and you think the risk of a sharp market decline is rising, then you will charge more to sell downside protection (ex: puts on the S&P) to another market participant — just as an insurance company would charge a client more for a homeowner’s policy in an area more likely to see hurricanes. And, in this vein, market makers are quick to aggressively raise the “insurance premium” if they are confronted with a shock event that leaves them with little-to-no information from which to evaluate risks.
That translates into the violent spikes in the VIX that you can see on the chart.
But, it’s important to note, betting a high VIX to persist, has been a bad bet.
Now, with this in mind, as we’ve discussed in historical crises Wall Street panics well before Main Street panics. And by the time Main Street panics and starts purging stocks, Wall Street is buying. That’s precisely what we’ve seen, this time around. In line with these actions, as you can see in the VIX chart, “the fear” on Wall Street, related to the health crisis, has subsided dramatically.
That’s the world of financial markets. But don’t underestimate the financial market mechanism for pricing in all of the information and laboriously weighing the risks and rewards.
So, what’s the takeaway: The market is telling us that that the psychology of fear on Main Street (which continues to be high) is way out of line with the reality of the health crisis (the status and outlook of which has improved dramatically). With businesses reopening and people returning to work, that Main Street fear should subside — maybe quickly, as people return to their life-learned patterns and behaviors.
Have a safe Memorial Day weekend!
If you are hunting for the right stocks to buy and need some help navigating the changing investing environment, join me in my Billionaire’s Portfolio. We have a roster of 20 billionaire-owned stocks that are positioned to be among the biggest winners as the market recovers.
