Dear Valued Clients and Friends –
The market was down a hundred points today, and basically stayed between flat and down one hundred all day. Oil remains around $34/barrel. Muni bonds continued about ten consecutive days of trading well. Corporates were off a tad. And syndicated loans seemed to be up a tad despite equity markets being off a tad.
Weekly initial jobless claims came in at 2.4 million, bringing the total number to 38 million since the COVID pandemic began (~8 million of those 38 million, though, are no longer on unemployment, presumably having found new jobs or re-secured their old job).
As for health data, case growth was +1.5% yesterday, absolute number of case growth is staying stubbornly above 20k/day, and increased testing is the explanation.
* Pantheon Macroeconomics, May 21. 2020
- Today’s testing data shows over 408,000 tests done today, with a positivity rate of 6.1%.
* The COVID Tracking Project, May 21, 2020
- One thing I did not know before analysis this morning was that the UK also saw its case growth increase when testing dramatically increased about a month ago, yet saw deaths decline throughout May, and have continued to decline.
* Pantheon Macroeconomics, May 21. 2020
- I think the data around states re-opening is vital towards educating us as to what is working and what is not, to guide ongoing safety decisions, and of course to provide the public confidence needed to resume daily living activities (most of which have direct economic implications). When we look at the COVID case growth in the states that have re-opened three weeks ago or longer, we see a steady decline of new cases, not a “surge,” and we also see a surge higher in new testing being done, suggesting the accurate interpretation of the data is even more encouraging.
- I watched an absolutely fascinating presentation the other day from Dr. Michael Roizen, the founder and Chief Wellness Officer of the famous Cleveland Clinic, and one of the most respected doctors in the country. The data supporting human behavior as the key ingredient in protection from COVID – hand washing, no face touching, no hair touching, food re-heating (I didn’t know that one), isolation of those with symptoms, etc. – was amazing. The regional differences in the spread of the diseases (NY vs. FL, TX, CA) continues to be something not fully understood in the medical community, whereas the comorbidity factors that have driven the fatality rate are now much clearer (obesity, high blood pressure, diabetes, immune suppression, lung disease, etc.), as is the central role senior facilities had in the spread and morbidity of the disease.
- Vaccine news filled the airwaves again today, this time on reports that the U.S. Biomedical Advanced Research and Development Authority has given AstraZeneca $1 billion in vaccine funding. AZ is a key R&D player in the Oxford University vaccine endeavor, and has agreed to produce 400 million (minimum), and as many as one billion doses of the vaccine upon approval. They are right now in a phase three clinical trial with 30,000 participants. This Jenner Institute/Oxford Vaccine Group joint venture has not provided a release of their trial data at this time, making such large government investment all the more noteworthy.
In market technicals, the underlying theme most technical analysts are focused on right now as it pertains to seeing another significant move down in stocks is what happens with the so-called “weak links.” Some volatile, vulnerable areas of financial markets that were at the very hub of market carnage in March include oil, copper, the banks, and credit spreads. We monitor all of these ourselves, with a particular focus on Oil and Credit Spreads. It is worth noting that all four areas – again, these more volatile and vulnerable “weak links” – are either strengthening or at least stabilizing.
* Strategas Research, Daily Technical Strategy Report, May 21, 2020, p. 1
- Credit spreads in particular have hit two-month lows, and it is impossible to not believe the Fed deserves part of the “credit” for this (okay, pun was intended).
- I am not thrilled to see the Put/Call ratio declining. More “Puts” to “Calls” means more people buying protection than opportunity, and as a contrarian, that is the sentiment I prefer to see. A lower ratio of puts to calls suggests more market complacency. The same can be true of the ratio of Bulls-to-Bears in investor sentiment surveys, most of which still show ample levels of pessimism, but much less “extreme pessimism” than we saw in March and April.
On the public policy front, Sen. Marco Rubio has indicated that they have the votes to amend the CARES ACT to extend the time beyond two months that businesses have to spend the borrowed money and still maintain eligibility for loan forgiveness.
Another very interesting development yesterday: The Treasury Department sold 20-year Treasury Bonds for the first time since 1986!! Why does this matter? I suspect they were testing the appetite for longer duration bonds (they sold $20 billion worth at 1.22%). Now, $20 billion is chump change in the grand scheme of federal government debt issuance. But the point is that there is significant appetite at very low yields for long duration government debt, and it makes no sense for our Treasury to not test the waters of 50-year or 100-year maturities, taking off the table one of the biggest tail risks people have suggested over the years – rising rates (in the future) substantially increasing debt service costs.
What do I care about government debt service? If they want to keep rolling over 1-year paper, trusting the Fed to keep short term rates brutally low, what’s the problem? Well, for one thing, risk elimination is risk elimination, but for another – a long duration U.S. government asset would give me a very substantial deflation hedge for my clients. I think it helps investors to have in their portfolio, and it helps the borrower (the U.S. federal government) to have in their term structure.
In the Oil and Energy world, because I illustrated yesterday the significance of crude oil wells in natural gas production, I think it is important to also demonstrate the significance of natural gas production, in the most practical parts of running our country. As coal has dramatically declined as a source of electricity generation in our country, it is the post-shale surge of natural gas that made up the difference, and allowed for that “trade.” Our production capacity impacts oil, yes, currently hampered by a declining rig count brought on by the economics of low oil prices. But that impacts natural gas production, because 32% of natty gas comes from oil well production. And that in turn impacts so many things – electricity production being an obvious one – because we have turned to natural gas as a cleaner alternative for so many day-to-day parts of American life.
As for Housing, the FHFA has announced that borrowers in forbearance may elect a deferral option whereby they (a) Resume making normal payments, and (b) Have the moneys owed from the missed monthly payments simply added to the back-end of the loan. So these payments will get made when the home is either sold, the loan re-financed, or the mortgage comes due. These loans where borrowers exercise this deferral option will remain in their agency MBS pools. Other options exist for borrowers who defer making mortgage payments – a repayment plan, reinstatements, and other custom modifications arranged between borrower and servicer.
Bottom line: Increased clarity is coming for how mortgage borrowers who skip payments can get made whole, and how their decisions will impact the investors in the bonds that hold their mortgages. It is bullish for CRT holders (Credit Risk Transfers I first wrote about here), and broadly helpful across Structured Credit.
And in Fed news, I will use this missive to reiterate one of the most needed economic reminders of this era, as my frequent harping of this issue in Dividend Cafe may be missed through the volume of that commentary … The Fed is increasing their balance sheet at rapid speed – that is, buying bonds with money that does not exist. It is called “quantitative easing,” and it is a monetary policy tool for accommodation. They Fed did this heavily from 2009-2014 (QE1, QE2, and QE3), and resumed the task en masse in March.
Expanding their balance sheet certainly holds down yields, but in and of itself it does not create new credit. Individuals and companies borrow when they have a need and demand for more credit to drive their production and consumption. Banks lend more to meet that demand. Now, post-financial crisis, banks have had stricter liquidity requirements and stricter capital requirements. That is a good thing – no one wants inadequately capitalized banks.
But my point is this: The Fed can create excess reserves at the banks out of thin air. It cannot create demand for credit which takes those reserves off the shelves of the banks (loan demand) and into the real economy. The delta between the two was crystal clear post-financial crisis.
I harp on this issue so that we will understand what the real risk is in this policy (distorting asset prices), and what the real risk is not (producing runaway inflation). I harp on it to demonstrate their real policy objective (holding down bond yields, supporting liquidity in financial markets), but also what their policy tools can not successfully create (actual credit demand in the economy).
The wildcards lie in these two categories, thus far still with no precedent in American monetary policy:
(1) The Fed lending (or using policy tools to get banks to lend) to firms that traditionally do not have access to bank capital. Emergency provisions in the Federal Reserve Act (13.3) have been used to do this in ways that we never thought possible before (Bear Stearns, AIG). Do we face a new round of monetary innovation in how the Fed attempts to stimulate credit growth?
(2) The Fed lending to the government itself (or more specifically, monetizing the debt of the Treasury directly).
It is very possible that we will see some of #1 throughout this COVID crisis. More and more QE has a rapidly diminishing return. More aggressive targeting of what they do with their facilities dos not.
As for #2 (a more overt MMT), I remain skeptical we will go there in the near future, and I remain desperate that we never go there.
The escalation of tensions between China and the U.S. are real, and an increase of popular hostility towards China in the COVID moment is giving U.S. policymakers to (a) Float peripheral policy ideas to jab at China, and (2) Escalate rhetoric about non-peripheral ideas that may not go anywhere, but do sound like a big deal. These escalations are real – and the currency exchange rate has moved up (Dollar up, Renminbi down) accordingly. The question for investors will be if and when politically palatable China legislation (or even rhetoric) gets serious, as opposed to merely peripheral. The market right now has absorbed jawboning and “policy sprinkles,” but I am less confident the market would take it well if it seriously escalates.
* Strategas Research, Policy Outlook, May 21, 2020, p. 1
I finished up today a virtual investment conference that has been running in different sessions (virtually) for the last two weeks, and was one of the best investment conferences I have ever been a part of (I spoke in two sessions, and listened to ~ten sessions). I will share some of the key takeaways very soon, but let’s just say my brain overfloweth with significant considerations!
And in the meantime … be well, be safe, be free.
David L. Bahnsen
Chief Investment Officer, Managing Partner
The Bahnsen Group
This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet