The Need for Safety Versus the Reopening of the Economy
The economic effects lead in one direction. The need for safety suggests another.
The economic calendar features many important reports – housing, consumer confidence, personal income, personal spending, and the Fed’s Beige Book. We now have April data for economic reports and May data for confidence. It is more relevant for seeing the extent of the economic damage. But it is not what people really want to know.
Everyone is making a personal decision about whether and how to venture out after a period of restrictions. There is a balance between the desire to enjoy freedom and the continuing fear of COVID-19. For business owners it is a question of how quickly to reopen and what precautions are necessary. For investors, it will be the first indication of how long the recession might last.
The economic effects lead in one direction. The need for safety suggests another. This leaves us asking:
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Can we balance these important goals as part of the Great Reopening?
Last Week Recap
In my last installment of WTWA, I argued that there were no shortcuts to an economic and stock market rebound. Mr. Market and the punditry certainly did not agree! Confident in the Fed’s arsenal and hopeful for an early vaccine, the market focused on the apparent success of reopening the economy.
The Story in One Chart
I always start my personal review of the week by looking at a great chart. This week I am featuring Jill Mislinski’s version, an excellent combination of the most important information.
The rally on Wednesday was attributed to optimism about an early vaccine discovery as well as Fed commentary. Thursday featured skepticism about the vaccine potential. The market gained 3.2% on the week. Because of Monday’s gap opening the trading range was only 2.3%. Measured from Monday’s close, the trading range was 4.1%. You can monitor market volatility, including historical comparisons. in my weekly Indicator Snapshot (below).
Like me, readers seemed to like this helpful depiction of what’s hot and what’s not. You can see the path of sector performance showing both leads and lags along with strengthening and weakening.
I am still looking for some time off. I’ll try again next week. I will keep posting fresh material on my resource page.
With expired Illinois plates for the last month, I ventured to an Arizona facility. I could not send anyone else nor could I do a first registration by mail. The office space was too small for any social distancing. Out of twenty people I was one of three wearing a mask. The clerks passed around my documents without gloves and did not wear masks. I was hopeful that my own mask would not spark any resentment since most of my fellow citizens “carry.” The registration fee was about $700. At least I will be able to do it by mail in the future.
Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!
New Deal Democrat’s high frequency indicators have always been a valuable part of my economic review. Over the next year we will watch for signs of the eventual economic rebound; NDD’s three different time frames will be especially helpful. The overall picture, terrible now and on short indicators and weakly positive on long indicators continues “once enough people correctly believe that it is safe to participate in the economy.”
Some of the “good” news fits the less bad description, especially if beating expectations. I do not intend this to sugar coat the terrible economic situation. It is simply a technique for taking note of changes.
- The Philly Fed Index for May registered a decline of 43.1, in line with expectations and better than April’s -56.6. It feels crazy to score this as good news, but it is important to track progress from the bottom. New orders, for example, are showing significant improvement.
- Leading Indicators for April declined 4.4%, better than expectations of -5.3% and much better than March’s (downwardly revised) -7.4%.
- The NAHB Housing Market Index for May registered 37, beating expectations of 34 and April’s 30.
Everything else declined significantly. Some of the March data still does not reflect the entire coronavirus effect.
- Housing starts(NYSEARCA:XHB) for April were only 891K (SAAR) missing expectations of 950K, and of course, much lower than March’s 1276K when the full Coronavirus effect did not show up. Calculated Risk notes that revisions were positive, and that the decline is not as sharp as in other sectors. Residential construction is considered to be essential. Bill’s observation is that we should expect the YoY weakness for “at least the next few months.”
- Initial jobless claims were 2.438M, slightly worse than expectations of 2.4M but better than the prior week’s (downwardly revised) 2.687M.
- Continuing claims continue to grow, reaching 25.073M, up from 22.548M. These are posted a week after initial claims, so we can be assured that the climb will continue.
- Mortgage applications declined by 2.6% versus growth of 0.3% in the prior week.
- Mortgage delinquencies are sharply higher (Calculated Risk). Loans in forbearance are counted as delinquent, but in about half of these cases the payments were made.
Existing home sales for April were 4.33M, in line with expectations but much worse than March’s 5.27M. Brian Wesbury writes:
We expect more softness in the near term as social distancing and government-mandated lockdowns weigh on activity, although April was likely the weakest month for sales. While it’s true that many realtors are using virtual-tour technology (NYSEARCA:XLK) to show homes to potential buyers, most people still want to see things in-person before they make one of the biggest purchasing decisions of their lives. Current quarantine restrictions and social distancing measures are also going to hold back a recovery in the inventory of existing homes, as fewer potential sellers list their properties.
COVID-19 Impact on Indigenous Peoples in the U.S.
analyzes the facts behind the disproportionate effects and the policy implications. To take one important example, New map gives detailed picture of coronavirus outbreak on Navajo Nation
shows the hardest-hit areas. There is also evidence of significant under-reporting.
Spanning Arizona, New Mexico and Utah, the Navajo Nation is vast yet sparsely populated: about 175,000 people live on the reservation, which is larger than 10 U.S. states.
Officials have enforced six straight weekend curfews and pleaded with people to stay home.
Donations have come in from all over the world. But challenges unique to the nation make containing COVID-19 extra difficult.
Social distancing is tough: Many extended families live together.
Basic prevention is impossible for some: 30% of Navajo Nation homes don’t have electricity or running water.
And health problems abound. The nation has disproportionately high rates of diabetes and hypertension.
President Jonathan Nez has said the nation’s health care system cannot manage so many sick people.
The Week Ahead
We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.
We have a big economic calendar in the holiday-shortened week ahead. Several reports on home sales and prices, April data on income and spending, and consumer confidence for May. Fed watchers can consider the PCE price index, a Fed favorite, and the Beige Book collection of regional reports.
What everyone wants to know most will remain a question. How goes the Great Reopening? We are probably still at least a week away from any meaningful reports on the pandemic and even farther from signs of the economic impact.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
Ready or not, the Great Reopening has begun. A part of the US believes that policies to stop the spread of COVID-19 were too extreme and perhaps not even necessary. Most others accept that a period of sacrifice, both financial and in personal freedom, was necessary. Like a pendulum, policies moved from emphasis on one goal to the other. Has this happened too quickly and is it going too far?
The question confronting everyone is a quest for balancing these goals as we begin the Great Reopening?
It is at the forefront of interest. My Google search for “great reopening” got 109 million hits.
In the United States, policies are typically compromises negotiated by contending forces. This is normally the result of interaction between legislative chambers or the legislature and an executive. The COVID-19 crisis created an exceptional situation. Executives invoked emergency powers, legislatures voted for or against restrictions (sometimes providing funds), and even the courts got involved.
There is no true national compromise since both the problem spots and the authorities are widespread and numerous. Adding to the complication: Decisions in one jurisdiction have implications for others. The Federal government has issued guidelines, but these are widely ignored by states. This means that the search for balance is fluid and swinging like a pendulum. Overreaching in either direction is likely, at least until there is more evidence. I will highlight the major issues in the quest for a balancing of policies.
#TestAndTrace is an excellent source on the progress toward a safe reopening. In addition to the summary map below, there is a detailed state-by-state analysis with frequent updates.
ProPublica also has a helpful state-by-state analysis which also tracks the change in cases.
State governments need a bailout, despite prudence during the crisis. (WSJ). Greg Ip concludes that failing to help the states forces them into a level of austerity that would damage the economy. Also What Would Happen If Congress Lets The States Go Broke?
“Think about what happens if the main breadwinner in a household loses a job,” said Barb Rosewicz, director of the State Fiscal Health project at the Pew Charitable Trusts. “There are things you stop spending money on — maybe you don’t put a new roof on your house, maybe you don’t save for your kid’s college education. Even if the head of the household gets a new job and the salary goes back to where it’s been, there are all these deferred investments you want to catch up on. And that’s how states got left after the last recession.”
And now, states are facing an even more devastating budget crisis.
PPP Delayed the Day of Reckoning for Small Business. Now, Time Is Almost Up.
Help from the program is about to run out for the earliest applicants. And don’t expect more help for recipients, since Senate Majority Leader McConnell has “vowed to end enhanced unemployment benefits” (Politico).
Implication: “Institutional investors are now split down the middle when it comes to the question of whether the government should do more to stabilize the economy or to ensure the health of the public.” (Institutional Investor Fear Index)
The Job Creators Network, a conservative advocacy group, is calling for a “second opinion” concerning Dr. Fauci’s conclusions. (Fox News).
The Vaccine Hope
There has been plenty of recent hope for a COVID-19 vaccine.
Without A Vaccine, Herd Immunity Won’t Save Us
concludes the 538. They provide an interactive model that allows you to make three key assumptions. The virus progresses showing the timing of consequences. I cannot do justice to this work with a single image, so check out the full post and make a few of your own assumptions.
Dr. Anthony Fauci believes that an aggressive investment now might make it possible to distribute millions of vaccine doses by the end of the year. (The Hill). This would require more up-front investment, including preparing to produce vaccines before they are proven and approved. And of course, most efforts would fail.
Less than two-thirds of Americans are “very” or “somewhat” interested in getting a COVID-19 vaccine if one becomes available, according to a Reuters/Ipsos poll released Thursday. About a quarter of those surveyed had little or no interest in taking a vaccine, Reuters reported, and more than 40% said the vaccine could be riskier than the disease. That’s a disturbing number, as medical experts say about 70% of the population would need to be be immune, either through vaccine or by fending off a previous infection, for herd immunity to prevent the further spread of the coronavirus. The poll also found a troubling gap in credibility. While 29% of those “not very” interested in a vaccine said they would be more interested if it had FDA approval, 36% of overall respondents said they would be less inclined to take a vaccine if President Donald Trump said it’s safe to do so, according to Reuters.
Quant Corner and Risk Analysis
I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update, featuring the Indicator Snapshot.
For a description of these sources, check here.
The C-Score spiked again. It is a dramatic change in underlying factors which normally provide important indications. This level is an extreme outlier that cannot readily be interpreted. Georg Vrba has paused the BCIp signal because of the extreme readings. It has done its job for now.
I have moved to a rating of “Bearish” in the overall outlook for long-term investors. I did some selling last week and plan to do more. I expect to replace positions with stocks that will do extremely well in an economic rebound.
The Featured Sources:
Bob Dieli: Business cycle analysis via the “C Score”.
Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.
Georg Vrba: Business cycle indicator and market timing tools.
David Moenning: Developer and “keeper” of the Indicator Wall.
Scott Grannis writes as follows:
So M2 has gone way up and GDP has gone way down because the forced shutdown of the economy has caused the demand for money to soar. That’s completely natural and predictable. The Fed has done the right thing by expanding the supply of money in order to accommodate the increased demand for money. The fact that inflation expectations, the dollar, and industrial commodity prices have been relatively stable for the past six weeks confirms that the Fed has accommodated soaring money demand, and has NOT been madly printing money. I’ve made similar arguments quite a few times in the past on this blog. Quantitative easing is NOT stimulus, it’s a badly-needed remedy for a huge increase in the demand for money.
But what comes next? With increased signs that the economy is reopening and activity is increasing, it’s quite likely that the demand for money will begin to decline as confidence slowly returns. Money that has been socked away in bank accounts is increasingly going to be spent on goods and services. Will the Fed be able to reverse its QE4 efforts in a timely fashion? Will the public’s desire to reduce their money balances lead to rising inflation?
He goes on to discuss the impact on specific industries, possible Fed policy changes, and the analyst reaction.
Consumer inflation expectations are now much higher than the market’s.
Insight for Investors
Investors should understand and embrace volatility(NYSEARCA:VXX). They should join my delight in a well-documented list of worries. As the worries are addressed or even resolved, the investor who looks beyond the obvious can collect handsomely.
Best of the Week
If I were to recommend a single must-read investment article this week, it would be Chuck Carnevale’s Why Record Corporate Debt Might Not Be So Bad: 8 Debt-Laden Blue Chips – Part 1. This analysis is especially important because of the misguided conventional wisdom. Investors, analysts, and writers point to high corporate debt levels as a looming threat both to the companies and to the overall economy. I have often been asked about this topic. My customary response is to ask the questioner to join me as the CFO of a major corporation. We can fund expansion or research via stock issuance or long-term debt. Which should we choose?
Chuck has taken my simple answer to another level with a close look at the data and his selection of blue-chip examples. He explains the need to look at per share comparisons and provides a great, must-watch video about the ability to handle debt.
Chuck then summarizes the key reasons:
The following graphic looks at three important metrics that perhaps helps explain why so many high-quality and even conservative companies seem to be behaving so recklessly with debt. In addition to the three companies above, I offer the additional five well-known companies where I look at return on invested capital (ROIC) their weighted average cost of capital (WACC) and finally their after-tax cost of debt. What should be clear from the below graphic is that debt is currently a very inexpensive and even efficient way for companies to capitalize their businesses.
He concludes that the decisions make sense if the company is able to sell Treasury stock to retire debt in the future. This highlights the key point.
Regardless, debt is an extremely cheap way for companies to raise money currently, and as long as they have “ammunition” (cash and Treasury stock) to pay back the debt, these high levels of debt may not be as bad as we all originally were taught to believe.
One caveat is in order: Companies may experience trouble if the price per share of its stock falls too low and renders the Treasury stock method of paying back debt useless. Of course, this risk has been temporarily heightened due to the financial stress from the COVID-19 economic shutdown.”
This is an excellent discussion of an important investing issue, backed with plenty of data and good examples. It is well worth a careful reading.
Here are a very few ideas to consider, keeping in mind the companies and sectors that will be viable after the Great Reset. Many sources are now considering the questions I have raised, but in more of a brainstorming fashion.
Altria (MO) may have lost its recession-resistant label but remains an attractive income opportunity at the current price. (Rida Morwa).
Blue Harbinger analyzes Ares Capital (ARCC), finding it to be among the safest BDCs. In general, I see this as a sector to avoid, so I urge readers to look carefully at the excellent description of risk factors at the end of the post. This is a hallmark of Blue Harbinger’s work.
Moderna (MRNA) made news this week with positive data from a small trial. The next day the critics were out in force. Piper Sandler biotech analyst Ted Tenthoff says that the vaccine could be “just the tip of the iceberg.” It is a reflection of the science behind the vaccine, demonstrating the potential for other vaccine products (Barron’s). My friend Paul Schatz has some suspicions about the timing of the announcement and a secondary offering. (In a special report to our clients who own the stock, I explained why I am untroubled by the timing and enthusiastic about MRNA’s future).
Kraft Heinz (KHC) is getting upgrades on the Street. It is benefitting from more home cooking. Will this trend continue?
Housing Stocks? This remains one of my favorite sectors, both now and after the Great Reset. Here are some current takes.
Covid-19 is squeezing the US housing supply
writes Karen Ho.
But while construction and sales slumped, there’s reason to believe demand is building. Low interest rates, the lifting of stay-at-home orders across several states, as well as growing inquiries in suburban areas from residents in expensive, high-density cities like San Francisco have helped increase demand for single-family, new homes, according to the latest housing market index (HMI) forecast from the National Association of Home Builders (NAHB) and Wells Fargo released yesterday.
The HMI is on a scale of 0 to 100 and measures the market’s appetite for home buying. After a significant drop in HMI between March (72) to April (30), May’s preliminary number on the index rose to 37.
Bidding wars in a pandemic? Housing is heating up fast
writes Diana Olick. Buyers are re-evaluating their space and features after three months of lockdown.
JPMorgan Bets on a Dash for the Suburbs
echoes many of the reasons from Diana Olick.
Signs Of V-Shaped Housing Recovery
have been spotted by Brad Thomas.
Homebuilders and the broader Hoya Capital Housing Index were among the standouts this week as recent high-frequency housing data has indicated that the housing market may indeed be the leader of the post-coronavirus economic rebound. The gains came following fresh data from Redfin (RDFN) that showed a “stunning” rebound in housing market activity over the last month as homebuying demand is now 16.5% above pre-coronavirus levels on a seasonally-adjusted basis, gains which have been “driven by record-low mortgage rates as pent-up demand is unleashed.”
And searches for “homes for sale” are up 54% (Housingwire).
The Great Reset
I am seeing many more articles on the themes I have suggested for The Great Reset. Here are a few examples.
With Earnings ‘Out the Window,’ Investors Turn to Survival Metrics: For sectors such as airlines, the outlook during the coronavirus pandemic is particularly cloudy. A traditional investing playbook no longer applies.
Airlines have been part of my early research. (And thanks to readers participating in the project. Our first Wisdom of Crowds survey went well. Expect more soon).
Finding good investments on the “other side” requires analyzes survival capability. Surviving businesses may represent great opportunities, “one of the most compelling investment environments” for aviation companies since 2001 – Dan Zwirn, chief executive and CIO of Arena Investors (Institutional Investor).
Continuing the survival theme, Moody’s warns about a “big default spike.”
Value investing and small caps
Cliff Asness analyzes some of the reasons for the big disparity.
Bottom-up economic impacts
One such concern is the impact on small businesses. Chamber of Commerce President Suzanne Clark explains the challenges to the three million members. One problem is “lack of clarity on how to move forward and how to interpret public-health data and guidance.” 30% are shuttered, at least temporarily.
If you look at April numbers, 80% of that job loss was in five sectors: medical services, retail, local education, government, and the big one—eight million jobs in food, travel, and events. Look back by sector to see which ones come back fastest—medical comes back fastest, and some services could come back, but we do know many of those [services] are small businesses. Whether they can survive long enough to reopen is more of the issue.
Watch out for
Crocs (CROX). More tough times ahead, mostly because of valuation (Barron’s).
I have several concerns about the current search for balance.
- It is too aggressive. I favor experiments, even by government. This one is too big, and too fast. My opinion is that we need more data.
- Political polarization has made the balance more difficult to achieve. A few readers have accused me of inserting my political views (as if anyone could really guess). I must use my conclusions about data, evidence, and the best experts to discover the right course for investors. I am investing a lot of time and effort in research. It is not just speculation. I regret that issues have become politicized, but we must work with what we have. Wearing or not wearing a mask has become a symbol.
- Even monitoring the progress requires data that remains questionable. The debate about overstatement or understatement of cases continues.
There will be a rebound in cases over the next month. Since many jurisdictions are unprepared to fight the local fires, the overall impact could be significant. There may not be another nationwide lockdown, but the economic effects will be substantial. We have missed the chance for a “U-shaped” recovery. Expect a rebound followed by another decline – a “W.”
We also face many moral questions. Some of these are decades old, but fresh for many people. There are no easy answers.
- What is the value of a life? This is a routine analysis in traffic safety decisions and wrongful death suits.
- Does it matter who dies?
- Wearing a mask is the simplest and easiest path to reduced risk. Even this requirement is controversial.
- How do we treat issues where one state’s rules affect another’s? Requiring motorcycle helmets is good analogy. That has been debated for decades.
- Should we perform drug trials without using a placebo? Normally the placebo group gets the current standard of care. In this case, the luck of the draw could be extremely important.
- Should we direct more aid to the areas that have been hit the hardest? What about other countries?
- Which nations should have “first dibs” (a genuine Chicago expression) on vaccines? The richest countries?
My respect for Dr. Robert Dieli rests on his unbiased use of data. His current mission is important and widely-shared – finding the trough in the new economic cycle. The challenge is how to use the data. Some plod along with their old methods. Others believe that the data tell us nothing. Here is Bob’s analysis of the data problem:
The current situation has two components. The first is the cyclical environment described by the model over the past several years. To wit, the transition from the Boom phase of the cycle to the Recession phase of the cycle. Those conditions were in place before the pandemic, and remain in place now. The second is the pandemic and its effects on economic activity. The pandemic is not a cyclical event any more than the polar vortex or the Greek debt crisis (remember that?) were cyclical events. The main difference between the pandemic and other events is its scale. We have never had an event of this magnitude and it is no wonder that our measurement devices are overwhelmed. Hence my mention of a Pandemic Adjusted EAS. This is not a replacement for the EAS, it is an effort to separate the pandemic effects from the cyclical events. And, more importantly, it is an effort to see how the pandemic effects are adding to the problems associated with the cyclical events. More on this in a moment.
He also sees a “W” in our future, but with pure economic reasoning. He is an expert on logistics and second-order effects. These will be coming. Any serious investor or manager should be reading Bob’s reports. Try a few and compare them to what you current depend upon. You will soon see the difference.
Enjoy a safe holiday weekend, sharing my respect for those we lost in service to our country. Have fun with family but follow the rules.
Remain calm, careful, and unemotional. The Great Reset provides an opportunity to revise your personal financial plan. Forget what stocks and sectors are winning now. What will work after the recession?
A Personal Request
One of my personal 2020 resolutions was even more emphasis on investor education – not just recommending stocks but learning how to find suitable choices. I have created a resource page where you can join my Great Reset group. You will get updates about what is being studied and can join in the process. There is no charge and no obligation, but I hope you will join in my Wisdom of Crowds surveys. I need more wise participants!
The results of our team effort will be published on a regular basis, so you will be joining me in contributing to a greater good.
I’m more worried about
- Ending arms control agreements and resuming nuclear testing? It has been almost 30 years since the last US test.
- State and local government finances. Revenue sources have been hit hard, but service demand remains high.
- Hong Kong restrictions and the US reaction.
I’m less worried about
- Scientific discovery and industrial innovation. I was pretty optimistic in my expectations for progress, but it is even better than I hoped.
- An emerging chance for an infrastructure program. This is something that could find support from both parties.