A Peek Under the Hood

A week after the massive selloff, here's the latest and what we can try to predict going forward.


Disclaimer: I am not a finance professional. I hold no licenses to trade or manage money. Do your own due diligence when investing your money. These views and opinions don’t necessarily reflect the views and opinions of CLNS Media.

Last weekend I gave my thoughts on what was the fastest 10% correction from all time highs in the history of the market. At that time, my advice was to not panic and to wait for a better price if you want to get out of equities. After what was an unbelievably volatile week in the market immediately following that article, I want to update my thoughts with more graphics, data, and the latest news points that figure to influence future moves. Here is an updated view of the chart I shared last weekend.

The setup in equities has deteriorated in my amateur trading opinion. I take this view for two reasons. First, though the S&P did indeed close higher on the week, it ended considerably below the highs of the week. Second, if not for a miraculous buyer frenzy in the final 30 minutes of trading, the market would have actually closed lower on the week.

Though the action looks very similar to what happened last Friday, a week ago the market was arguably rallying on hope for an emergency rate cut from the Federal Reserve. Tuesday morning, the market received its coveted rate cut and sold off on the news anyway. So now, broad market equities are marginally higher than where they were a week ago despite the Fed already utilizing one of the few “tools” it has. This is not a reason to be bullish.

Speaking of interest rates, US treasury yields have absolutely collapsed year to date. The speed of the decline has been breathtaking the last two weeks. The ten year note is now yielding just 77 basis points.

Right now US T-bills held to expiration return less than the official inflation number. This means that real yields on US bonds are now negative. Others may disagree, but I view this as incredibly detrimental to the United States’ ability to sell treasuries to foreign bond buyers. Because so many foreign bonds have already been negative yielding, US sovereign debt was the best horse in the glue factory before yields collapsed. Now, I’m not so sure that’s the case.

It’s fair to wonder if buying equities to gamble on capital appreciation via multiple expansion makes some sense if bonds provide no yield. The problem there is corporate debt has essentially doubled since the last recession.

Even if we accept that Coronavirus won’t wreak economic havoc domestically (not sure I agree), the fact that China has been effectively closed for business and under quarantine puts the global economy at serious risk of widespread recession. China has a direct impact on 20% of world GDP. Without the Chinese supply chain, global conglomerates with high debt levels who are reliant on China might not be able to satisfy payments on those obligations. This could put these kinds of companies at bankruptcy risk. Companies at risk of bankruptcy don’t usually see their stock prices go up. We can see this in real time in the oil market. As the price of oil collapses to factor in global recession risk, oil producers are plummeting to Financial Crisis valuations. Companies with higher production costs are feeling the pain even worse.

And that leads us to the Fed and “tool” number 2. Helicopter money. Fed apologists like CNBC’s Steve Liesman are now actively campaigning for Fed stimulus. And there is little doubt that a stimulus package on a grand scale is coming. The White House just announced a funding plan of $8.3 billion and the virus hasn’t even really gotten bad domestically yet. What happens when economic conditions get even more uncomfortable before the election in November? New York declared a state of emergency this afternoon. A massive cash infusion is coming, you can book it.

Where will that cash go? If the financial crisis taught us anything, it’s that entities deemed “too big to fail” will get bailed out. Bailouts mean balance sheet expansion. Balance sheet expansion means currency debasement. Currency debasement means appreciation of inflation hedges.

In summary: bonds no longer provide real yield. If you can’t get a real yield from bonds, your investment options while staring down a recession look pitiful. While a flight to equities that aren’t a bankruptcy risk could happen, that might be completely dependent on stimulus. The pet rock looks nice in either circumstance though. It also happens to be up 10.4% since I wrote this. And yes that’s better than the S&P 500 return over the same time period even including dividends.