Friday, June 19, 2020

Powell's Potent Put Powering Stock Market Meltup

From meltdown to meltup. The Greenspan Put, the Bernanke Put, and the Yellen Put all resulted from actions taken by the Fed under those three Fed chairs to give stock prices a boost when they seemed to need it to avert a meltdown. The Powell Put saved the day in late 2018 when the Fed chair started to pivot away from raising the federal funds rate in 2019 to actually lowering it three times instead. The S&P 500 soared 44.0% from December 24, 2018 to a record high on February 19, 2020.

On March 11, the World Health Organization declared that the COVID-19 outbreak had turned into a global pandemic. The pandemic of fear spread just as rapidly in the US capital markets, especially in the bond markets, which seized up as credit-quality yield spreads soared.

On Sunday, March 15, the Fed responded by cutting the federal funds rate by 100bps to zero and announcing a $700 billion QE4 program of Treasury and mortgage-backed securities purchases. That week, the governors of California and New York issued executive orders requiring nonessential workers to stay home. Credit-quality spreads continued to widen significantly. So on March 23, the Fed introduced QE4ever and posted term sheets on five major credit facilities.

Three of the new facilities dated back to the Great Financial Crisis and were reactivated. The big shockers were the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF). For the first time ever, the Fed was going to lend a hand to the investment-grade corporate bond market. On Monday, June 15, the Fed announced that the SMCCF would start buying corporate debt, and promised to activate the PMCCF soon, as discussed below.

In response to the Great Virus Crisis, Powell provided the biggest Fed put of them all, boosting both stock and corporate bond prices. The result has been to stop the 33.9% meltdown in the S&P 500, which lasted from February 19 through March 23. I'm not sure that deserves to be categorized as a bear market since it lasted only 23 trading days with declines exceeding 20% during only seven of those days! In any event, the meltdown was followed by a meltup with the S&P 500 soaring 44.5% through June 5.

The Fed's actions stopped the credit crunch and allowed corporations to raise piles of money at record low interest rates:

(1) Corporate bond yields. The Aaa-rated and Baa-rated corporate bond yields fell to record lows of 2.44% and 3.45% on Monday, June 15 (Fig. 1 and Fig. 2).

(2) Corporate bond issuance. Over the 12 months through April, nonfinancial corporations raised a record $1,175 billion. I estimate that at least half of that was used to refinance outstanding bonds (Fig. 3 and Fig. 4).

No asset left behind. The Fed is intent on offsetting the adverse impact on financial markets resulting from any flare up in the first wave of the viral pandemic or any second wave that might emerge after the first wave. The stock market sold off sharply last Thursday on fears that reopening the economy will lead to less social distancing triggering another wave of the virus. The market rebounded a bit on Friday, but then proceeded to fall again Monday morning on unsettling news over the weekend about rising cases of infection around the country.

Have no fear, the Fed is here with another wave of liquidity:

(1) Secondary facility is first. At 2:00 pm on Monday, the Fed released a press release with the following rather detailed headline, “Federal Reserve Board announces updates to Secondary Market Corporate Credit Facility (SMCCF), which will begin buying a broad and diversified portfolio of corporate bonds to support market liquidity and the availability of credit for large employers.”

The Fed announced that it was expanding its Secondary Market Corporate Credit Facility (SMCCF) to purchase individual corporate bonds to complement its current purchases of exchange-traded funds. This special purpose vehicle (SPV) is capitalized with $25 billion provided by the Treasury under the CARES Act, and can leverage that up by 10-to-1 to $250 billion.

But wait, there’s much more: The SPV includes the Primary Market Corporate Credit Facility (PMCCF), which will be able to leverage $50 billion in capital to purchase up to $500 billion in corporate bonds directly from issuers.

As part of its (almost) no-asset-left-behind (NALB) program, the SMCCF will purchase bonds rated BBB-/Baa3 (the lowest investment-grade category) as of March 22, 2020, but were subsequently downgraded to junk. Nevertheless, they must be rated at least BB-/Ba3 as of the date on which the facility makes a purchase. These so-called “fallen angels” accounted for 50% of outstanding investment-grade bonds before the virus hit the fan.

The SMCCF began purchasing eligible ETFs on May 12 and will begin purchasing corporate bonds on June 16. Purchases are expected to cease no later than September 30 of this year.

(2) Primary facility is second. The PMCCF is expected to become operational in the near future. Additional details on the PMCCF are forthcoming. It will provide companies access to credit by purchasing qualifying bonds as the sole investor in a bond issuance, or purchasing portions of syndicated loans or bonds at issuance. (For more, see FAQs: Primary Market Corporate Credit Facility and Secondary Market Corporate Credit Facility.)

(3) A big drop in the bucket. A billion here, a billion there, adds up to $750 billion in financial support for the corporate sector. The Fed’s recently released Financial Accounts of the United States shows that during Q1, nonfinancial corporate bonds outstanding totaled a record $6.0 trillion and loans totaled $3.8 trillion (Fig. 5). Loans from depository institutions totaled $1.3 trillion, while “other loans” (including leveraged loans) totaled $1.9 trillion (Fig. 6).

(4) Zombies on life support. The Fed issued its first semi-annual Financial Stability Report during November 2018. The latest one was issued May 2020. All four reports recognized that there was too much dodgy corporate debt. Here is what the latest report had to say on the subject:

“At the beginning of 2020, about half of investment-grade debt outstanding was rated in the lowest category of the investment-grade range (triple-B)—near an all-time high. The amount of debt downgraded from investment grade to speculative grade in 2019 was close to the historical average over the past five years. However, almost $125 billion of nonfinancial investment-grade corporate debt has been downgraded to speculative grade since late February, and expected defaults may rise if the economic outlook and corporate earnings are revised downward. Widespread downgrades of bonds to speculative-grade ratings could lead investors to accelerate the sale of downgraded bonds, possibly generating market dislocation and downward price pressures in a segment of the corporate bond market known to exhibit relatively low liquidity.”

The report sounded the alarm on leveraged loans as well:

“Defaults on leveraged loans ticked up in February and March and are likely to continue to increase, with the specific contour highly dependent on the path of overall economic activity. Such developments would weaken the balance sheets of lenders, including CLOs that hold leveraged loans, and amplify the economic effects of COVID-19.”

During his October 30, 2019 press conference, Fed Chair Jerome Powell was asked about financial stability. He responded: “Obviously, plenty of households are not in great shape financially, but in the aggregate, the household sector’s in a very good place. That leaves businesses, which is where the issue has been. Leverage among corporations and other forms of business, private businesses, is historically high. We’ve been monitoring it carefully and taking appropriate steps.” He didn’t specify those steps. However, the Fed’s three interest-rate cuts during 2019 undoubtedly kept lots of zombies alive and fed their appetite for more debt.

As a result of the Great Virus Crisis, we now know how Powell is dealing with the corporate debt crisis. He is buying lots of it and enabling corporations to issue much more of it!

Thursday, June 11, 2020

MAMU: The Mother of All Meltups

As of Friday June 5, the S&P 500 was up 42.8% since March 23. This 52-day meltup is historic. It is the best since bigger gains were recorded during August-September 1932 (up as much as 109.2%) and May-June 1933 (up as much as 73.2%).

The meltup started the day after March 23, when the Federal Reserve announced QE4Ever and started carpet-bombing the financial markets and the economy with B-52s full of cash (Fig. 1). Since then, the Fed’s balance sheet rose by $2.5 trillion to a record $7.1 trillion during the June 3 week (Fig. 2). Its holdings of Treasury securities increased $1.6 trillion over the same period to a record $4.1 trillion (Fig. 3).

The Fed actually started its bombing campaign on March 15, when it announced $700 billion of QE4 purchases of US Treasuries and mortgage-backed securities and lowered the federal funds rate by 100bps to zero. The European Central Bank (ECB) joined the allied bombing campaign on March 18 with its Pandemic Emergency Purchase Programme (PEPP), committing to buy €750 billion of private- and public-sector Eurozone securities. On June 4, the ECB upped the ante by €600 billion to a total of €1,350 billion (Fig. 4). The total assets of the Fed, ECB, and Bank of Japan have soared by $3.9 trillion from mid-March through the end of May to $19.1 trillion (Fig. 5).

The result has been the Mother of All Meltups (MAMU) (Fig. 6).

During the bull market in stocks from 2009 through 2019, some bullish investment strategists claimed that “there is no alternative” to stocks. “TINA” was their stock market rallying cry. In fact, there was a good alternative to stocks, namely bonds. The 10-year Treasury bond yield was 2.89% on March 9, 2009, when the previous bull market started. It fell to a record low of 0.54% on March 9 of this year.

TINA makes more sense during the current bull market than it did during the previous one. The embrace of Modern Monetary Theory (MMT) by US monetary and fiscal policymakers during the week of March 23, when the Fed announced QE4Ever, and on March 27, when the CARES Act was signed into law, triggered a huge wave of TINA rebalancing out of bonds and into stocks. It is likely to continue for the foreseeable future.

The stock market equation since March 23 has been: TINA + MMT = MAMU.

MMT ended the latest bear market, which lasted for just 33 calendar days from February 19 through March 23. During that period, there were 23 trading days, with the S&P 500 down by 20% or more during only seven of those days. Technically, it was still in bear market territory, as the S&P 500 rocketed 18.9% for 11 more trading days after the March 23 bottom, through April 7, before entering correction territory.

Nevertheless, I’m not convinced that the selloff should be classified as a bear market since it was so short. It was more like previous panic attacks during the bull market, which started on March 9, 2009. At the beginning of this year, on February 2, I added the COVID-19 outbreak as Panic Attack #66 on my list with a January 24 date, when the bad news first hit the tape. (See Table of S&P 500 Panic Attacks Since 2009.) It’s staying there in my record books!

On Friday, the forward P/Es of the S&P 500, S&P 400, and S&P 600 jumped to 22.6, 23.1, and 26.1, respectively (Fig. 7). Here’s the latest performance derby of the major MSCI stock price indexes since March 23 through Friday’s close in local currencies: US (43.6), All Country World (37.4), EMU (35.2), Emerging Markets (28.5), UK (28.5), and Japan (25.4) (Fig. 8). Here are their forward P/Es on May 28: US (22.1), EMU (16.3), Japan (15.3), UK (15.1), and Emerging Markets (12.9) (Fig. 9).

Long live the bull market! Now we have to worry that MAMU might lead to its demise since meltups tend to be followed by meltdowns!

Thursday, June 4, 2020

Economic Alphabet Soup: V, U, Z, W, L or Swoosh?

Will the economic recovery be shaped like a V, U, W, L, or Z? Cases can be made for all of these possibilities. There are other possible shapes to the recovery such as a square root sign, and even a “swoosh,” like Nike’s logo. Schematic diagrams of these alternatives can be seen in a May 11 WSJ article titled “Why the Economic Recovery Will Be More of a ‘Swoosh’ Than V-Shaped.”

In the past, economic recoveries from most recessions tended to be V-shaped. The experience of the Great Depression suggests that recoveries after such a severe downturn should be shaped more like an L or W. The recovery following the Great Recession of 2008 was widely perceived to be U-shaped.

The article cited above observed: “Until recently, many policy makers and corporate executives were hoping for a V-shaped economic recovery from the coronavirus pandemic: a short, sharp collapse followed by a bounce back to pre-virus levels of activity. Now, however, they expect a ‘swoosh’ recovery. Named after the Nike logo, it predicts a large drop followed by a painfully slow recovery, with many Western economies, including the U.S. and Europe, not back to 2019 levels of output until late next year—or beyond.”

Consider the following:

(1) Real GDP cycles. The y/y growth rate in real GDP has been mostly V-shaped during recessions and recoveries since 1948 (Fig. 1). There were two nearly back-to-back recessions during the early 1980s with up and down legs that resembled a W. The recovery in the early 2000s appears like a U. While economic growth was subpar and U-shaped during the expansion following the Great Recession, the initial recovery was V-shaped.

Following the June 1 release of the latest purchasing managers survey and construction spending reports, the Atlanta Fed’s GDPNow tracking model estimated that real GDP fell 52.8% (q/q, saar) during Q2, a bit worse than the -51.2% of the May 29 estimate. This increases the likelihood of a V-shaped recovery during Q3 and Q4, with my estimated gains of 20% and 5% (Fig. 2). Beyond that, I agree that it could be a swoosh with low single-digit growth rates. I don’t expect that real GDP will recover back to its Q4-2019 record high until late 2022.

(2) Recoveries in coincident indicators. I track the monthly Index of Coincident Economic Indicators (CEI) as a useful proxy for the quarterly real GDP series (Fig. 3). This index includes four coincident economic indicators: employees on nonagricultural payrolls, real personal income less transfer payments, industrial production, and real manufacturing & trade sales.

The CEI shows that the average time that it took for the economy to recover to its previous peak during the past six economic cycles was 33 months, ranging between 19 months (in the early 1970s) and 68 months (following the Great Recession).

I think it could take 32 months to get back to the February peak in this series, i.e., by October 2022. So the initial V-shaped rebound could eventually turn out to be a swoosh. This outlook allows for the possibility of a second wave of COVID-19 infections, though not as bad as the first wave and without another round of lockdowns.

(3) The first recession in services. Increasing the likelihood of a swoosh rather than a sustainable V-shaped recovery is the fact that the current recession is the first one that has been experienced by—and indeed led by—the services sector of our economy. In the past, recessions were led by downturns in manufacturing and construction. Most services industries were either relatively unaffected or actually continued to grow during previous recessions, while goods production declined, as can be seen by comparing goods versus services in real GDP (Fig. 4).

A glance at historical charts of industrial production and housing starts shows that both typically have V-shaped recoveries (Fig. 5 and Fig. 6). They are likely to do so again this time. The same is not likely to happen for retailers, restaurants, airlines, hotels, casinos, entertainment, and recreation. The article cited above noted:

“Among the reasons for the darker outlook is that lockdowns are being eased more slowly than originally expected in some countries. Even when they do lift, some large-scale activities—such as concerts and professional sports—won’t be possible again for months. Retailers and restaurants that have reopened are allowing in fewer customers at a time due to social distancing. And consumers worried about infection risks may take a long time to return to their old habits.”

(4) Feedback loops and aftershocks. The slow pace of recovery in service-producing industries could, in turn, weigh on the recovery in goods-producing industries. If, in fact, working from home (or from smaller suburban offices) catches on after the Great Virus Crisis (GVC), there is likely to be less business travel, which will depress airlines, hotels, restaurants, and convention centers. Commercial construction of offices, hotels, and retail stores is likely to be hurt by social-distancing aftershocks from the GVC, especially if the virus remains active because an effective vaccine isn’t discovered. Demand for new commercial jets is also likely to remain depressed since the airlines industry is unlikely to be back to business as usual for at least two to three years, if not longer.

(5) Surviving the car crash. One important industry that is very likely to experience a V-shaped recovery during the second half of this year is auto manufacturing, though that also is likely to turn into a swoosh during 2021 and 2022. The Fed’s monthly data on US motor vehicle assemblies plunged from 11.1 million units (saar) during February to 0.1 million units during April (Fig. 7). That’s extraordinary: The auto industry was essentially shut down during April, along with most other businesses.

Production is likely to bounce back smartly in coming months. Sales of domestic-make autos also fell but were well above zero at 6.7 million units during April, though that was down from 13.2 million units during February. That’s actually impressive given that many auto dealerships were affected by the lockdowns. Both sales and output should recover in coming months as the lockdown restrictions are lifted, with the latter outpacing the former.

By the way, contributing to the sharp increase in April’s personal saving rate was the drop in personal consumption expenditures on new motor vehicles and parts. It fell from $814 billion (saar) during February to $528 billion during April (Fig. 8). Since the full value of new auto sales is included in current consumption, that $286 billion drop boosted personal saving by the same amount.