Market has continued to trade in a tight range with declining volumes over the last few days but yesterday after the EU close, US has started to fall considerably on intraday lows.
Europe is set to open down 1.3/1.4%, still within the range we had since the beginning of April but it seems increasingly difficult for the market to bounce further.
Having said that, positioning is still light from the main market actors and the below is the current situation:
– Risk-parity fund equity beta at 10 year lows
– CTAs are still short equities
– Hedge Funds net leverage is at multi-year lows
– US equity futures positioning is at multi-year lows
Although positioning is still a significant tailwind the concerns of equity supply, incremental bad news as a second wave of contagion/longer duration restrictions and trade concerns get priced and it might mean sideways or lower for a bit in most indices.
US futures positioning has played an important role in the recent moves higher. Since the sell-off began on 24th of February, Morgan Stanley has calculated that the buy-side had initiated $97 billion of new shorts. In the rally of over 20% from the recent lows on the 23rd of March, there were only $24 billion of these shorts being covered, according to CFTC Commitments of Traders data. Over the week ended on the 5th of May, the buy-side sold a modest amount of US Index futures (totaling $10.3 billion notional), driven by a mix of liquidating longs and covering shorts. With this selling, the buy-side’s net long position in US Equity Index futures remains notably below average since 2010 (at just 2% of total open interest vs 10% average).
Another important factor that we have discussed few days ago is about the “buy the close, sell the open” effect especially on US markets. The trend has continued over the last few days and the largest percentage of the S&P (positive) move on an overnight basis has happened last month with roughly a 10% move upwards from the 4th of April until the 5th of May. This chart clearly show the different moves for the S&P during the different time shifts.
Central banks and Government actions
The amount monetary supply that has been put into work during the virus outbreak is impressive. We have about 8-10Trln$ of global Central Banks accommodative easing with an unseen percentage vs global Gdp.
As Ray Dalio recently published, we are in a debt crisis. Printing and devaluing money is the easiest way out of a debt crisis, and it’s being used. We are seeing big devaluations and a potential “end of reserve currency” periods, because the USD, EUR and Yen are in the late stages of their Long-Term Debt Cycles meaning debt denominated in them are high, real interest rate compensations for holding this debt is low and large amounts of new debt denominated in them are being created to fund the historic levels of accommodation.
We believe that there is no much attention currently to Currency Risks but with the time we should start to focus on those risks along with less deflation.
April is normally a surplus month for the US Treasury as income tax payments come due. Not this year. The US government’s sweeping fiscal effort to contain the economic damage from the coronavirus pandemic generated a record $737.9 billion deficit last month alone! Through the first seven months of fiscal year 2020, the budget deficit now stands at $1.48 trillion, compared with $530.9 billion at the same point last year.
Yesterday, the Fed’s secondary market corporate credit facility has begun purchasing of ETFs whose primary investment objective is exposure to US Investment grade and High yield corporate bonds, as already announced a month ago in the emergency lending program.
The move is a milestone for the Fed, which hasn’t bought ETFs previously.
The central bank, recognizing it would take longer to buy bonds, saw ETFs as a fast way to direct money rapidly into credit markets, said people familiar with the matter.
To speed up implementation, the Fed will acquire those ETFs via primary dealers, mainly Blackrock, the largest ETF provider and the biggest Asset Manager in the world. Among the most common eligible ETFs we find LQD (iBoxx $ Liquid IG), HYG (iBoxx $ Liquid High Yield) and JNK (Bloomberg Barclays High Yield). More eligible ETFs in the chart below.
Even with the Fed literally saying that it’s highly unlikely to pursue negative interest rates any time soon, bets on sub-zero rates aren’t going to disappear as currently there are negative yields already priced on future contracts and Trump recent comments seems to be in that direction.
US Elections and taxes
It is probably too early to start talking about taxes as an investable theme but it’s something that keeps rattling in the back of our minds.
With record deficit spending to stem the impact from unemployment, how long can this persist unfunded?
One has to wonder, if social distancing will need to remain in place for another 1-2 years what is the structural impact on unemployment? Which politician will be bold enough to curtail the employment support if working class voters clearly need it?
History tells us that the winners in a crisis end up being the pariahs of the future. The world was bifurcated before the virus hit, with a record wealth gap that Covid has only exacerbated. If there is one major concern that can de-rail the rally in secular growth/stay-at-home plays is if the US election takes a populist swing pitting the working class against the small pocket mega caps that have disproportionately benefited from this environment.
Trump is facing an uphill battle going into the election with a struggling economy, a stagnant national approval rating according to the Real Clear Politics average and with that the NYT is reporting that older voters are less likely to vote for Trump this year, a demographic that preferred Trump over Clinton 53%-45% in 2016.
Vice President Biden has a growing lead in head to head polling against President Trump in swing states.
Turning to Capitol Hill, using PredictIt data, the conditional probabilities of the Democrats taking the Senate if they win the Presidency is now >90%. This implies there is a greater likelihood some Democratic policies getting enacted than the market is pricing.
Increasing taxes is one thing that most Democrats agree on, making it a likely prospect for legislation. In a Democratic Administration, a tax changes could pass with a simple majority in a Democratic controlled House and Senate via reconciliation.
Corporations are currently subject to a 21% corporate tax rate (18% effective) post the Trump tax cut, from 35% (26% effective) previously. If the tax law is reversed, Goldman has predicted that 2021 EPS would fall by $19 and imply a P/E multiple roughly 15% higher than the already stretched valuation.
From an earnings perspective, Goldman predicts that every 1% change in the effective corporate tax rate would lead to a roughly -2.5% change in S&P 500 EPS. So, even if Biden only reverses half of the cut, as he has proposed, this could still cause a 10% hit to S&P 500 EPS.
Something to keep in mind.
WTI Oil price rose 6.7% hovering around $25.5 per barrel while Brent jumped 1.2% at 29.5$ per barrel yesterday, following signs of a recovery in demand due to easing of lockdowns in some key countries, along with Saudi Arabia cutting production to the lowest level in 18 years. Global oil consumption may be increasing as volume of fuel sold by retailers across US jumped to 7% last week, Indian fuel is set to increase 25% in May MoM, and more and more Chinese are driving to avoid public transport boosting demand. Overall WTI still down 60% YTD, while Brent down 55% YTD.
Saudi Arabia aims to pump under 7.5 million barrels per day in June, 1 million barrel per day lower than now, along with Kuwait and UAE additionally curbing 80k and 100k barrel per day respectively. According to the IMF, Saudi Arabia needs an oil price of $76 a barrel to balance its budget this year. The government is struggling with the current oil price, and tripled value added tax and cut bureaucrats allowance to decrease its fiscal deficit, set to reach 13% in 2020. Fitch currently sees Gulf Cooperation Countries deficit to soar between 15-25% in 2020.
Despite all of these cuts, that’s still short of the daily demand reduction of almost 15 million barrels estimated by the International Energy Agency. Oil demand should slowly improve over the next weeks for the effect of the easing of lockdown.
The chart below doesn’t take account for the “non official” cuts, the ones done by the companies which have been growing considerably over the past two months and are likely to grow in the near future.
Aramco, Saudi state oil company, reported 25% decline in Q1 2020 profits, but paid a dividend of $18.75 billion in Q1 2020, and confirmed to be on track to meet its full-year dividend goal of $75 billion. It continues to forecast between $25-30 billion of Capex in 2020, but 2021 is uncertain. Clearly, we will see a strong deterioration in Aramco’s financial metrics in Q2 2020. Just think that a stress test carried out by JPM, showed that if oil fell down to $40 per barrel (it’s much lower now) and production was at 9 million barrels a day (it will be 7.5 million in June), Aramco would remain in its self-imposed borrowing targets if it cut dividend by 30% and slashed Capex massively.
Inventories build are slowing in US and elsewhere, with the rampant accumulation of oil inventories set to drop for the first time since January, as stockpiles increased by 4 million barrels a day in the week to May 3, compared with a peak surge of 10 million a day in April. Many US shale driller companies are reopening the oil wells in a sign that oil price might have already bottomed out.
DOE Crude Oil Total Inventory
Very interesting chart showing the ongoing recovery, mainly in China, with copper stockpiles declining from the highest level since 2018 at record speed (black line), while the price of copper (blue line) jumped almost 50% since its March lows.
Copper inventories (black) vs Copper price (blue)
We have seen worrisome signs of deflationary forces in China. Consumer Price Index rose just 3.3% in April, sliding 1% from March versus consensus of 3.7% due to a drop in food inflation. This was the lowest print since September 2019 when China was suffering from an acute surge in food prices driven by pork hyperinflation.
Producer Price Inflation, a proxy for corporate profits, tumbled to -3.1%, more than double the March decline of -1.5%, missing consensus estimate of a -2.5% drop, and the lowest print since April 2016. Factory deflation makes it hard for companies to generate profits and expand businesses. Interestingly, we are looking forward to seeing Chinese Industrial production, retail sales and fixed investment on Friday May 15.
CPI change YoY (red) vs PPI change YoY (blue)
A similar chart with a danger for US deflation is shown below. US April Core Consumer price Index, which excludes volatile food and fuel costs, decreased 0.4% vs -0.2% consensus from -0.1% in March, the biggest monthly decline ever. Headline Consumer Prices fell 0.8% MoM, the biggest drop since 2008, as soaring food inflation was dominated by plunging energy, apparel, and lodging costs. More properly, a 20% decline in the gasoline index was the largest contributor to this massive monthly inflation decrease. In the chart below, we show that good deflation is accelerating while service inflation is slumping.
US Core PCE (black line) vs US CPI (orange line) vs Fed objective (dotted purple)
According to Mediobanca, the Italian economy risks losing GDP equivalent to the whole of the Veneto region this year, or 170 billion euros, due to the coronavirus. Italy was the worst off in the G7 with a 9.1% loss of GDP in 2020, It is the worst crisis since WWII.