The Markets are in a Suspended Animation Perpetuating a Denial of Reality

By: Uri Estrin - June 30, 2020 08:31pm EST
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Markets are in a flight of suspended fancifulness
Markets are in a flight of suspended fancifulness

We’re approaching the end of June and the markets today broadly rallied. General sentiment is good, the Dow not too far off its rebound highs and the Nasdaq shy of its all time high. This is off a bull run that’s lasted nearly two decades.

This prolonged bull market is in itself unusual given it’s longevity and precipitously highly debt issuance. It is in denial of an over leveraged, disproportionate economy. And this was all preceding a world wide pandemic. The growth of the last decade has been anemic at best. The Fed was taking extraordinary measures last year to quell the 10% spike in short term repo market rates, among other measures to support an economy still in recovery more than 10 years later. All pointing to signs of an overdue recession, which I had been calling for sometime, but finally vindicated with it’s February 2020 arrival.

So given this backdrop of instability and market fragility, how can in the midst of a pandemic the markets not only recover so almost completely, but maintain their recovery stamina?

First, outside of major hot zones like Italy and New York (and even within), the majority of the population realized that while the numbers were catastrophic, Covid wasn’t going to spread immediately into the majority of the population. Second, there is a denialist sense of ‘it won’t happen to me, so I’m ok’. Then the US Government pumped in $3T of stimulus. It gave forgivable loans to companies to not fire their employees, it gave most citizens $1200 and extended federal unemployment by $600/week on top of State unemployment. Couple that with the Fed’s balance sheet increase of roughly the same amount and the economy has $6T pushed immediately into the system. A trillion here, a trillion there, it’s a lot of money. That is 30% of 2019’s GDP injected over a space of a couple of months.

So the markets are awash with money and the promise that Uncle Fed will save anything and everything – that’s great – a boost to sentiment and a stock market roars back. Buffet got grilled for sitting it out, while all the new stay at home day investors apparently make oodles of paper profits on their app – Buffet knows the inherent risk in this type of rally, the newbies do not. Let’s see how it ends. Remember, you don’t make a profit until you sell (the IRS will back me up on this), you can’t spend paper profits.

 

Question is, why are we still here? Why is the market still exuberant? The market is waiting for more stimulus, which I’m pretty sure it will receive. But there is another issue that no one is talking about.

It’s a data vacuum with very little reporting. The first quarter of 2020 came in with -5% GDP. That’s not great, but given the cataclysmic events, it’s within the scope of a quick recovery. However, the shutdown effectively started towards the end of March so Q1’s big drop is disproportionately affect by the last 2 weeks of the quarter. This does not augur well for Q2. Likewise with corporate earnings.


The only other significantly meaningful numbers at this time are the jobs figures. Around 20 Million Americans are unemployed, with reports of under reporting. This in itself should have devastated the markets. But given the stimulus, you have unemployed people with greater income than when employed, companies holding onto employees that would otherwise have been let go and money sloshing around everywhere. This keeps the markets happy.

 

In May, the unemployment figure dropped to 13.3% - great news – going in the right direction, buy into the equities rally. What the markets negated to digest was that the previous record for weekly jobless numbers was set in back in 1982 with 682,000. We have had 14+ weeks of jobless claims above 1M per week. Think about that – 14 weeks, each setting a record double the 1982 record. That in itself is incredible. The markets have ignored these numbers instead focusing on the paltry improvements from week to week. The rest of the numbers, given the events, are baseless.

 

Here is why we are in ‘Suspended Animation’ and further, why I think we are soon to get a reality check;

End of July we see the Q2 GDP estimate and by all predictions it’s going to be a very sobering number (anywhere from -10% to -30%), end of July the $600/week federal unemployment stimulus bonus comes to an end, the corporate PPP should already just about have run its course and companies are going to start retrenching or even closing down against a backdrop of record breaking new infection numbers across the US.

Reality has to hit home, it’s a matter of time and it looks like its sooner than the markets may think. It’s a perfect storm waiting to hit and things are going to get a lot rougher before they get better. The markets may discount all of the above with a false sense that we are in for a v-shaped recovery and none of this matters because it will be back to business as usual by the fourth quarter. I strongly disagree. We were heading into a recession and due for a correction before Covid appeared. This is just an exogenous factor that hastened this realignment, not caused it. There is more to impending down trend.

When over indebted companies who can’t re-open, or can reopen with limited capacity or have no customers, face an impossible operating environment without PPP support, they will have to layoff workers and/or close down. We are potentially heading back into lockdowns for some areas of the country. This will have knock on effects where I see the unemployment numbers getting worse before they get better, disturbing the market’s current disposition. When the unemployed aren’t receiving additional stimulus – this aggravates the cycle.

Treasuries had a sell off into the stimulus injection. But recently, yields have steadily been declining again. The affects of the stimulus are waning, the Bond Market knows this. Treasuries are still a great bet. Crashing GDP, rising unemployment and bankruptcies all pointing to deflationary, deleveraging forces. Long Bonds Treasury yields will be pushed down sharply and with that substantial capital gains potential.

When the V-shape doesn’t present itself, the Markets will be really rattled. I’m in agreement with wide consensus – Jerome Powell and the IMF among others - who are not anticipating a swift v-shaped recovery. I am even more pessimistic. It’s a long way from started to open up to full swing exuberance. We sit on decades of debt indulgence, over issuance of corporate bonds, unproductive capital, zombie corporations, large economic segments built solely around discretionary income, unicorn corporation with no hope of profitability and over extended, over indebted consumers. The coming deleveraging will be painfully long and far past where the expected upside to the V was suppose to be.


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