Stock Market is often disconnected from the real economy

For years, I have seen many stock market bubbles form and then burst. Stock market experts seem to sing the same old tune. They are looking beyond present conditions toward what they believe will happen in the future. Bubbles usually form when there is too much optimism and tend to burst when the economic reality sets in.

The basic human suffering from Covid-19 gets more and more insane by the day. The reality on the ground is that the spread of Covid 19 is getting worse in the U.S. and other parts of the world, not better.

Why then have money managers continued to push stock prices higher?

  1. They believe that whatever is happening today doesn’t matter, but it is where we are going tomorrow that matters.  In this case, tomorrow is 2021.
  2. Government stimulus measures seem to have lessened some investor fears. The CARES Act, the $2.2 trillion coronavirus relief package issued one-time stimulus payments to American households. It expanded unemployment benefits and created a forgivable loan program for small businesses.
  3. The Federal Reserve has also used aggressive measures to make sure businesses and municipalities can access ready cash.
  4. Investor optimism has been buoyed by phased state reopenings that have begun across the country and the expectation of a vaccine.
  5. There has been a rebound in consumer spending and some companies are rehiring.
  6. A survey of financial advisors suggests they’re taking a rosy view over the long term. A quarter of advisors expect to increase their stock recommendations to clients over the next year.

Here is a dose of reality

It turns out that much of the S&P 500 returns come from just 10 companies: Microsoft, Apple, Amazon, Google, Facebook, Visa, Mastercard, Nvidia, Netflix, and Adobe. As a group they are up 35% since the beginning of the year. As a group, the other 490 are down more than 10%.

Just three stocks make up more than a third of the Nasdaq 100 Index. I bet you can guess which three. Apple, Amazon and Microsoft together are now valued at nearly $5 trillion. That’s larger than the entire economy of Germany and nearly the size of the Japanese economy

In a true bull market, you see most stocks rising, often to new highs. A rising tide should lift nearly all boats. The percentage of NYSE stocks closing above their 200-day moving average is only 37% but it was near 70% in January.

The market has already assumed that current earnings will be bad. Analyst earnings projections tend to overestimate even in good times and analysts tend to have a herd mentality, usually tracking one another. I found a chart by Jim Bianco to illustrate a possible valuation bubble.

 

The problem with stock market bubbles is you can never predict when they will burst. The most notable one was the dot com bubble that formed from 1995 to 2000 and burst in 2001. There are a few stocks today that are valued similar to some of the past dot com stocks.

Tesla is a perfect example, it has a market value of 262 billion based on sales revenue of 25 billion. You can also add Shopify to the bubble list that has a market value at 110 billion with only 1.7 billion in sales revenue.

Some economic reality may set in next week with the release of second quarter GDP on Thursday July 30. (Analysts are expecting a decline of 33%), along with Friday’s release of consumer spending, Chicago’s purchasing managers index (PMI) and consumer sentiment index.

 

 

Wall Street ignoring the economic pain on Main Street

Are you mystified that the S&P 500 is only down 13% from its February high and the NASDAQ is slightly positive year to date? You would think that all the bad economic numbers would dampen investor’s confidence in owning stocks. However, publicly trading companies on Wall Street have a number of advantages over Main Street.

  1. When it comes to government bailouts and subsidies, large public companies seem to be first in line. There are always claims that help is needed to save jobs or what they produce is an essential product or service. However, many of these companies used their cash to buy back stock and pay big executive bonuses instead of saving for a rainy day. (Airline industry)
  2. The Federal Reserve’s zero interest rate policy helps large public companies to sell bonds at low rates to stay afloat, a huge advantage over small and medium sized privately owned companies.
  3. The Federal Reserve has the bond and stock market’s back.  They are adding liquidity to the bond market by buying corporate debt and even buying high yield or junk bonds to keep interest rates low. This allows even the worst run companies to avoid bankruptcy.

Why I think that Wall Street shouldn’t be so optimistic regarding an economic recovery:

I agree with comments made by Fed Chair Jerome Powell who cautioned of a potential credit crunch as stimulus dollars start to dry up. The result would be the loss of thousands of small and medium sized businesses across the country. Owners of many bars, restaurants, gyms and clothing stores have stated that they are fearful of being able to cover their operating costs while limiting the number of customers allowed into their premises.

So far, 32 publicly traded companies have already filed for bankruptcy protection under chapter 11 which leaves many of their employees, suppliers and shareholders high and dry. The economic pain from Covid 19 could be long lasting as more companies file for bankruptcy protection. The recovery may take some time to gather momentum as some jobs will never come back.

It is hard to comprehend that Wall Street is dismissing the fact that all the jobs that were created over the past ten years have disappeared in just under three months. . The weekly jobless claims will continue to be momentous and don’t included workers who want a full time job but are working part time. It also doesn’t include many Americans who are out of work and don’t qualify for unemployment insurance.

I wonder, is it even possible to get people back to work without safely opening up schools and daycares? France reopened their schools last week and 70 new cases of Covid 19 were found in seven schools forcing them to close them again. A new concern for parents is an outbreak of a inflammatory syndrome in children that is linked to Covid 19. Cases of Inflammatory syndrome  have been diagnosed in 27 states in the United States.

Doctors have warned that many U.S. states have reopened without meeting CDC guidelines. The number of positive cases have spiked already in 14 states over the past few weeks. A rising death toll in the U.S. hasn’t stop many Americans from avoiding large social gatherings, ignoring social distancing guidelines and refusing to wearing a mask. There is a high probability that another spike in cases and deaths will dampen consumer spending.

Lastly baby boomers, (60 to 75 years old) have the most disposable income and also face the highest risk of dying from Covid 19. As a baby boomer, I will be avoiding the all travel and leisure activities.

  • Air travel
  • Cruising
  • Resorts and hotels
  • Movie theatres
  • Sit down restaurants
  • Casinos
  • Theme parks
  • Sporting events
  • Concerts

I will avoid anywhere there is large gathering or requires close personal contact.  I am not going to risk my life to get a haircut or go to my local pub to watch a sporting event. It is just a matter of time when Wall Street profits will be affected by lack of consumer spending.

 

Signs that this recession will be more severe than 2008-09

 

The last time we had zero interest rates was during the great recession of 2008-09. If you are a movie buff, that was one scary horror movie. Unfortunately, the sequel maybe even scarier. The plot, so far, is similar in many ways. The world faces a major crisis with high unemployment, massive government spending (bailouts), zero interest rates and central banks printing money.

How do you make a horror movie scarier than the original? The writer has to intensify the plot line and add some terrifying developments not seen in the original movie.

  • This crisis affects the whole world with every economy feeling the pain.
  • The percentage of people unemployed could be worse than the great depression of the 1930’s (25% or more)
  • The government stimulus package was in the billions last time and now in the trillions with more to come.
  • Central banks are buying huge amounts of government debt and now are buying low grade corporate debt. (Even some junk bonds)

More terrifying developments

  • Although tragic that many consumers lost their homes in the last recession, small business failures will have a more negative effect on the economy. Small businesses are responsible for employing 48% of the U.S. workforce and have generated 65% of net new jobs over the past 17 years. The unemployment rate will be higher for longer.
  • Consumer spending accounts for 70% of economy growth. Unemployed consumers will have less money to spend. Plus, images of body bags and continuing daily death counts will inhibit consumers from risking their lives to go out and even spend money.  The last recession had little impact on travel, movie theaters, theme parks, sporting events, restaurants and bars. These businesses will continue to suffer until consumer confidence returns
  • The last recession didn’t produce long lines at grocery stores. Disruption of food production was unheard of and has become a real concern as some meat packaging plants have been forced to temporarily shut down. A shortage of fruit and vegetables could be next as migrate workers could face high rates of infection.
  • Normally a drop in oil prices has a positive effect on consumer spending but a total collapse does more harm than good. Oil companies have started to suspend capital expenditures, cut dividend payouts and reduced their workforce. Countries which depend on revenues from oil production will face large budget deficits making it harder for them to stimulate their economies.
  • Food banks are experiencing a surge from a high number of people who have never needed their help before. Images of long line ups are popping up all over the United States.

 

 

  • There was a coordinated world response to the financial crisis which is sorely lacking in dealing with this pandemic. Too many leaders are more concern with keeping their jobs than going their job.

 

 

The spread of misinformation by some world leaders and some media outlets could cause a second wave of this virus. The image below is an example of irresponsible leadership. Some of these people will get sick and some may even die. However, they will also spread the virus to their families, their friends and critical medical personal at hospitals. Being a Canadian, I hope that a change in leadership in the United States will help the North American economies recover sooner rather than later.

How will this horror movie end? My best guess is when a scientist shows up holding a treatment in one hand and a vaccine in the other!

 

Stay tune for some investment ideas during these turbulent times.

 

 

 

Op-Ed: I am less optimistic of a V shape recovery

It is difficult to write a financial blog when the death count from Corvid -19 keeps going up every day. However, the big question is when we will get back to normal? I think you have to look back in history at the Spanish flu of 1918 for some clues.

Policies used to reduce the spread of Corvid -19 are similar to what was done to reduce the spread of the Spanish flu. Unfortunately, isolation, quarantine of infected people, use of disinfectants and limitations of public gatherings were applied unevenly. (Sounds familiar?) Back then, the Spanish flu came in waves and infected 500 million people, about a third of the world’s population. It lasted from Jan 2018 until Dec 1920 and somewhere around 50 million people died.

I fear that world leaders are more worried about keeping their jobs then doing their jobs. Their slow reaction of issuing stay at home orders for non-essential workers will prolong the spread of the Corvid-19. In my humble opinion, a V-shape recovery is overly optimistic.

 

The roll out of government programs to get money into the hands of individuals, small business and bailouts of large corporation will take a long time to be effective.

  • Many government websites are crashing from the number of requests for aid.
  • Many small businesses will go bankrupt before the relief funds arrive.
  • The aid to  businesses are in the form of loans which add extra operating costs, this will hider rehiring employees.
  • The United States had 16.5 million unemployment applications over the past three weeks which is just a small sampling of what is to come.
  • This is a world recession so leisure and travel will be impacted for a long time. Plus business travel, conventions and hotel stays will be limited.

The best case scenario would be a slow and cautious U shape economic recovery. What is needed is accurate testing of people who would be allowed to go back to work.  Also, a quick development of a vaccine and an effective treatment for people who are infected with the virus.

The worse case scenario would be an L or W shape economic recovery. Rushing to reopen the whole economy could cause a second wave of the Covid-19 outbreak, killing thousands of more people and shutting down businesses all over again.

I am not investing based on stock market experts who tend to be overly optimistic. I am listening to the doctors who specialize on disease control. Their timeline of a vaccine is 12 to 18 months away. Therefore this recession will probably last around 18 to 24 months. The chart below illustrates that happen to the S&P 500 during the last recession of 2008-09:

This chart illustrates the past two years of the S&P:

I am not an expert on charts but I think that there is a good chance that what we are seeing is a bear market rally. There is more bad news coming that hasn’t been priced into stock prices. I would suggest that you play it safe and sell into stock market rallies and hold on to your cash.

Save lives and stay at home. The life you save may be your own!

 

 

 

 

 

Why interest rate cuts won’t save the economy or the stock market

This week, after an emergency call with central bank leaders around the world, the Federal Reserve cut interest rates. A somewhat surprising move coming about two weeks before its next scheduled meeting. It was the first emergency rate cut by the Fed since the financial crisis in 2008 and a strong signal that the central bank is taking the threat of the virus seriously.

The problem is that cutting interest rates, which were already very low, isn’t likely to do much to solve the kinds of economic problems posed by a pandemic.

Think of it like this: if more people get sick, more people can’t work. Businesses become less productive and ailing workers without paid sick leave don’t earn money. (They might also go to work sick.) Meanwhile, others who are either sick or afraid of catching the virus stop going out and spending money.

Restaurants, movie theaters, hotels and airlines have already experienced less revenue. More workers will lose their jobs temporary, so fewer people will have money to spend. Its classic cause of an economic downturn since the U.S. economy depends on consumers’ spending money.

Crucially, all the people out of work will still need money for food and housing costs. The new record-low mortgage rates aren’t going to solve that immediate problem, especially not for renters. Nearly 4 in 10 adults would have trouble handling a $400 emergency expense, according to a recent study from the Federal Reserve.

An economic downturn is coming, the problem is no one knows how severe it will be and how long will it last. China’s economy took a big hit and government took some draconian measures that can’t be done here in North America.

Some precautionary financial steps

  1. Top up your emergency fund
  2. Living pay check to paycheck: then get a line of credit or increase the limits on your credit cards
  3. Start looking for day care services in case of school closures
  4. Don’t put any new money into the stock market until the coronavirus is contained. (Too early to buy the dips, however make an investment shopping list)
  5. Get ready to refinance your debt, but keep in mind that there could be more rate cuts.

Why you shouldn’t panic over a decline in stock market prices

The chart below illustrate what happen to stock market values during the financial crisis. (Jan 2008 until Mar 2011) The left side of the graph shows the market hit bottom in Mar of 2009 and recovered most of it losses by Mar of 2011. I not suggesting that this current market downturn will get that bad.

Keep in mind that the stock market has gone straight up since the market hit bottom back in march of 2009 with a few little blips. The chart below illustrates that the current downturn could be just another blip. This virus will only have a temporary effect on the economy and consumer spending will recover. People will travel again, visit theme parks, eat out and business will be profitable again.

Back in September, I wrote a post to reduce some of your risk and move some money into dividend paying stocks. I hope that you followed my advice.  Dividend income should help to offset some of the fall in value of your portfolio.

 

 

 

Opinion: The Fed cutting interest rates could be a big mistake

Stock market watchers are expecting a rate cut this week because they believe that the U.S. economy is experiencing a slowdown. Second quarter GDP growth was 2.1% which is lower than the 3.1% growth rate during the first quarter. However, consumer spending rose 4.3% despite the fact that tax refunds were smaller than previous years. The GOP tax cuts did increase the weekly take home pay for consumers which accounts for some of the strong spending.

Growth deceleration in the second quarter was due mostly to tariffs and a fear of a global slowdown.  China’s economic growth has slumped to its lowest level in nearly three decades due to the prolonged trade war with the United States. However, the biggest drag on the U.S. economy has been a slump in business investment which was down 5.5 percent.

It is hard for corporations to spend money with Trump’s tariff threats on most of its trading partners. The new NAFTA or USMCA hasn’t even been approved by Congress; then add the uncertainty of a smooth Brexit (Britain leaving the European Union) and you a recipe for a slowdown in business spending.  In reality the Trump administration is partly to blame for the slump in world economic growth.

In order for the Trump administration to win the trade war they need interest rate cuts in order to lower the value of the U.S. dollar so that their tariffs are more effective. China can easily lower the value of their currency compared to the U.S. because the Federal Reserve is an independent agency.

Why I believe that lowering U.S. interest rates is a bad idea!

  1. Trump has relentlessly used social media to criticize the Fed. To remain independent, the Fed has to resist political pressure.
  2. Unemployment is at the lowest level in decades; the economy doesn’t need more stimulus.
  3. Lowering interest rates will enable Trump to pursue a more aggressive use of tariffs which in turn will further slow world economic growth.
  4. Cheap money will allow corporations to buy back more of their shares adding debt to their balance sheet.
  5. Low interest rates will encourage more wasteful government spending, adding to the already large national debt.
  6. Pension plans will get less interest on fixed income investments making it more difficult to meet their monthly commitments.
  7. Consumers will get less interest on their savings accounts.

Conclusion: Cutting interest rates could make matters worse. It could prolong the trade war with China and enable the Trump administration to actually follow through with threats of imposing more tariffs on their other trading partners.

 

 

 

 

 

 

 

Reality Check on Trump’s tax cuts and trade deals

Image result for april fools with Trump

Let me start with Larry Kudlow, the Director of the National Economic Council, who said back in April of 2018 that he believes the U.S. tax cuts could generate GDP growth of 5 percent annually for a short time. The U.S. economy did manage a 4.2% GDP growth in the second quarter of 2018 but the annual rate was only 3.1 percent. Sorry, forever Trumpers but Obama had 2.9% GDP growth in 2015 without the tax cuts.

GDP growth projections even fooled the Federal Reserve which signaled three rate hikes for 2019 but the slow down in world economic growth has forced the Fed to put any more rate hikes on hold. Market watchers believe there is a strong possibility that the Fed may have to cut rates if U.S. growth continues to slow down.

April fools : Tax cuts will for pay themselves

  • The budget deficit grew 77 percent in the first four months of fiscal 2019 compared with the same period in 2018, the U.S. Treasury reported earlier this month. The total deficit was $310 billion up from $176 billion over the same four-month period a year earlier. The cause of the massive increase, according to Treasury officials: tax revenues fell dramatically and government spending increased significantly. Even worse news is that the budget deficit is projected to exceed $1 trillion in 2020.
  • The national debt, which has exceeded $21 trillion, will soar to more than $33 trillion in 2028, according to the non-partisan Congressional Budget Office (CBO). By then, debt held by the public will almost match the size of the nation’s economy, reaching 96 percent of gross domestic product, a higher level than any point since just after World War II and well past the level that economists say could court a crisis.

Trump campaigned on a promise to shrink the country’s trade deficit, arguing loudly during campaign stops before and after taking office that bad trade deals have allowed other countries to take advantage of the United States. Trump imposed tariffs as a way to reduce the trade deficit with America’s trading partners.

April Fools: Imposing tariffs will reduce the U.S. trade deficit

The U.S. trade deficit hit a 10-year high in 2018, growing by $69 billion, according to figures released March 6 by the Census Bureau. Trump’s constant verbal blasts and a number of arm-twisting PR stunts focused on efforts to revive American manufacturing and reduce dependence on imported goods such as steel and other materials failed to produce any meaningful results.

Trump promised to scuttle all those bad trade deals and replace them with pacts that would re-energize our country’s manufacturing sector. Very little has happened on any of those items during the past two years.

Yes, Trump pulled the United States out of the Trans-Pacific Partnership and renegotiated the North American Free Trade Agreement, both of which he called some of the “worst” deals”, and he’s currently pursuing separate deals with China and the European Union.

It’s important to note, however, that Trump has signed just one new trade deal, with South Korea. The NAFTA replacement, known as the US-Mexico-Canada Agreement, still needs to be approved by Congress and lawmakers on both sides of the aisle have raised concerns. Canada and Mexico will not ratify the new agreement unless the U.S. remove the tariffs on steel and aluminium

So far, engaging in trade wars with just about any country America does business with has not delivered promised results of more jobs for U.S. workers. Companies are not relocating manufacturing plants back to America.

 

Image result for no joke

 

Santa Claus rally, No, No, No?

Image result for santa claus rally

Is there any hope for a Santa Claus rally this year? What are the chances the markets could reverse the worst December since 1931?

A Santa Claus rally, which would begin on Monday, is a very specific event. It is the tendency for the market to rise in the last five trading days of the year and the first two of the New Year. According to the Stock Trader’s Almanac, it is good for an average gain of 1.3% in the S&P since 1950.

What caused the Dow Jones Industrial Average to have its worst week since the financial crisis in 2008, down nearly 7 percent and cause the Nasdaq to close down into bear market territory?

  1. The Federal Reserve’s rate hike on Wednesday drove the losses this week and investors were hoping for a more dovish tone regarding future rate hikes. Despite the fact that Chairman Powell reduced the projected number rate hikes from three to two and reduced the neutral rate to 2.8% from 3%.
  2. In my humble opinion, President Trump is partly to blame for the severity of the losses this week due to his criticism of the Fed.  He backed Powell into a corner and forced him to show that the Fed is an independent institution. (the Fed could have put more emphasis on being data dependent) According to some reports, Trump has also discussed firing Powell privately because of his frustration with stock market losses in recent months.
  3. In an extensive interview at the White House on Thursday, Trump’s trade adviser, Peter Navarro said that it would be “difficult” for the U.S. and China to arrive at an agreement after the 90-day period of talks unless Beijing was prepared for a full overhaul of its trade and industrial practices.
  4. Political chaos in Washington with partial government shutdown, sudden withdrawal of troops out of Syria and the resignation of Defensive Secretary Mattis.

Investors are still worried about:

  • A slowdown in economic growth as more companies scale back their sales growth and profit outlook for 2019
  • Fear that a flat yield curve will invert if the Fed continues to hike short-term interest rates
  • The unwinding of the Fed’s balance sheet will reduce the availability of credit for corporations
  • The trade war with China will escalate causing more inflation
  • More economists are jumping on the recession bandwagon for 2020
  • Political chaos in Washington will get even worse when the Democrats take power in January

A dead cat bounce is a possibility in January

Image result for dead cat bounce

dead cat bounce is a small short-lived recovery from a prolonged decline or a bear market that is followed by the continuation of the down turn. You need nerves of steel to trade a dead cat bounce but for long-term investors it could be a good time to reduce market risk and re-balance your portfolio.

Image result for merry christmas cat

Blame Yellen and Trump for rapid raising U.S. interest rates

  

I believe that the former head of the Federal Reserve, Janet Yellen, is partly responsible for rapid raising U.S. interest rates. Although, GDP growth wasn’t overheating during her term, she could have started to unwind the Fed’s balance sheet which had 4 trillion dollars’ worth of treasuries. Instead she bought more treasuries after they matured and expanded the balance sheet by buying more treasuries with the interest earned.

This kept long term interest rate extremely low and allowed corporations to borrow money at low rates to buy back their shares. The Fed’s lack of action has help fuel the longest bull market in history.

Sorry Trump supporters but your man is also to blame. His policies are inflationary!

  1. The trump’s administration decision to pull out of the Iran deal has cause oil prices to rise. One million barrels of oil a day is being taken off the market.
  2. Trump’s tariff war with China and other trading partners will force corporations to increase prices because their costs are going up. Costs could go up even higher if Trump increases tariffs on imports from China from 10% to 25% in January 2019
  3. The corporate tax cuts and government spending has juiced the economy causing unemployment to fall to the lowest level in nearly fifty years sparking fears of raising wage growth.

The Trump’s administration spin that the tax cuts will pay for themselves is simply not true. Both the Reagan and Bush tax cuts added to the fiscal deficit.

The new Fed chairman, Jerome Powell has a difficult job of unwinding the Fed’s balance sheet by buying less treasuries just as the federal government is issuing more debt to cover the Trump’s tax cuts. Trump will add another trillion dollars to the deficit. More supply of treasuries plus less buyers equals raising interest rates.

Trump blaming Powell for the massive drop in the stock market last week is ridiculous. No one knows for sure what caused investors to hit the sell button. Was it fear of raising interest rates, a forecast of slower global growth by the IMF, fear of an escalating trade war with China or fear of runaway inflation.

My guess is all or none of the above. Maybe the stock market was just due for a correction.