The market has finally managed to stop at least temporarily the meltdown. European futures are indicated up 2% this morning. You can find below many interesting points and the reason why we have increased the weight on all our products yesterday. It seems that the short sell ban on many European countries has helped.  It might have been a coincidence but UK stocks were the weakest yesterday likely due to the absence of a short selling ban. Oil has bounced 23.8% yesterday and is up 3% this morning also supported by the US Energy Department, which said it will buy 77 million barrels of oil to fill the nation’s strategic petroleum reserve.

 

A typical allocation style which puts 60% in shares and 40% in fixed income is set for the worst month in its 16-year history.

The recent equity market move by many metrics was last seen in 1929. Market depth has virtually disappeared (~90% decline relative to the past year average),  gamma hedging (index options, levered ETFs) and systematic flows have produced a market that regularly moves 10% intraday, pushing the VIX to all-time highs. High volatility has pulled liquidity causing a crunch.

With large option expiry today, a great portion of short gamma will expire. This should reduce volatility going forward.

 

Central banks have entered with full power measures

We have all been critical of the ECB in the past few weeks about the message that monetary policy was close to its limits but this has changed completely now with the new asset purchase program and the way they have communicated to markets.

The Pandemic Emergency Purchase Program (PEPP) in addition to the liquidity provided by LTROs and T-LTROS are a significant backstop, with the economy also supported by a significant fiscal boost.

The ECB changed the universe of eligible assets along two dimensions. Public sector purchases under PEPP will extend to Greek government debt. In addition, non-financial commercial paper of sufficient credit quality will be included in the Corporate Sector Purchase Programme (CSPP), expanding the range of assets eligible under both the APP and PEPP programmes.

Greek bonds are below investment grade and the fact that they are now eligible for purchase means that all periphery is now on board.

 

As a result, the Italian 10Y yield which was on Wednesday at 3% was yesterday trading at 1.6%.

 

EU leaders are apparently looking into activating ESM credit lines (European Stability Mechanism) to help fund national fiscal responses, which could in turn open the door for OMT (Outright Monetary Transactions) purchases.

Access to the ESM could be made easier, so as to allow a speedier response. Such a programme would then allow the ECB to step up asset purchases even further via OMT.

 

The Fed has decided to step up the daily purchase of the initially-planned $50 billion QE, to $75 billion per day today and tomorrow in order to maintain ample reserve balances in the system and to support the smooth functioning of the Treasury market.

 

Fed daily QE

 

The Fed, following the massive global funding needs, has established temporary US dollar liquidity arrangements (swap lines), in place for 6 months, with Australia, Brazil, Denmark, Korea, Mexico, Norway, New Zealand, Singapore and Sweden, for as much as $90 billion, in an effort to reduce the incredible appreciation pressure on the USD currency. The global shortage of dollars is probably the issue confronting markets at the moment. So far, The Fed had swap lines outstanding to 14 central banks.

 

 

The BOE has cut rates by 15bps to 0.1% after the 50bps cut made on the 11th and has increased bond purchase program by 200bnGbp

 

Total announced stimulus in Europe, US and UK this week was $4.2 trillion. US $1.3 trillion fiscal stimulus will be likely funded issuing ultra-long bonds, including 50-year and 25-year bonds, which should be the the lowest cost option to taxpayers. In the chart below you can see how yields on US 10Y and 30Y Treasuries went sharply higher, which it makes sense as fiscal stimulus should steepen each yield curve.

 

 

Technicals & Positioning

 

The S&P has completed a DeMark 9 short term buy signal.

Nasdaq futures are trading at the same levels we traded over the last 5 days. Is it building a base and getting ready for some short covering?

Nasdaq futures 10 minutes chart

Today there is one of the most important expiries of futures & options on history with the aggregate $delta of puts expiring set to be the largest on record (on a gross open interest basis).

With dealers short those puts and short stock against them to hedge, the expiration is likely to bring a large net buy flow and order of magnitude could be tens of billions to buy since as the puts expire, dealers need to buy back the stock hedge that is no longer needed.

In addition, there will be soon a wild month-end pensions and asset allocator rebalance which normally starts 5-day before the end of the month.

It should have a similar effect to the expiry due today.

 

In terms of positioning, Systematic strategies are slowing their selling pressure and the last funds that were agressively selling over the last days, Risk Parity, are now done being invested only at the 6th percentile as shown on chart. While we have warning over the last months about the potential sell-off because of these funds, now the negative effect has finally gone.

 

Over the past week, a record 249bn$ poured into US Government momey-market funds as investors are seeking refuge in high-quality liquid assets. Total assets rose to an all-time high of 3.09trn$.

At the same time, Prime money-market funds, which tend to invest in higher-risk assets such as commercial paper, saw outflows of $85.4 billion.

 

Bonds and Credit

Liquidity stress is driving the market and cash is underperforming. Like we mentioned yesterday morning, bonds trading at discount to ETF NAV, symptom of liquidity stress.

There are several downgrades on BBB bonds and Credit spreads are continuing to widen. We are worried about a potential wave of defaults.

As an example, Ford yesterday has withdrawn the guidance it gave for 2020 financial performance and suspended the dividend. 5-year CDS are currently pricing almost 50% default probability.

Another example is given by the credit spread of few triple-B US Oil companies which has more than quadrupled to above 1000bps from below 225bps in mid-February as a plunge of oil price below 30$ shocked the market.

 

In less than two weeks, the amount of distressed debt in the US alone has doubled to a half-trillion dollars as the collapse of oil prices and the fallout from the coronavirus shutters entire industries.

Distressed debt is a term used to describe the borrowings of companies that are perceived to be under acute financial pressure and often suggests that there’s considerable risk those borrowers will default on their obligations.

The junk ex-energy spread is at the highest since 2011 and the next stop is 2009 peaks at much wider levels. Meanwhile, high-yield is on track for the biggest quarterly loss since 2008. Energy sector bonds are down 34% this month alone. All other sectors are down significantly, even utilities. As we said several times, we are yet to see a further implosion in the high yield segment as earnings collapse, defaults spike and liquidity evaporates.

Bloomberg Barclays US High Yield Ex Energy spread

 

Another big concern is about the continuous rise in real rates. 2 year US inflation breakeven have dropped to -80bps having been +1.5% 1 month ago (10yr from 1.6 to 0.6).

If disinflation cannot be abated we could find ourselves in what Ben Bernanke fought so hard to prevent in the last crisis, a “Deflationary debt spiral.”

 

In Germany while a few sessions ago investors lent money in panic to Germany at -0.9%, now they demand -0.17%, the highest since November last year.

Valuations

As we have update you over last days, valuations are now back to recession levels, with a P/E forward hovering around 10x for Europe and less than 14x for the US, thereby providing some cushion for those able to stomach high realized volatility in the near term and for those awaiting a U recovery later in the year.

Let’s not forget that even during bear markets we had sharp rebounds.

During the 11 recessions since World War II, the S&P 500 experienced an average peak-to-trough decline of 30%. The 19% correction sparked by the 1998 Russian sovereign debt default was followed by a 28% rally during the subsequent six months. The 19% drop in 2011 during the Eurozone debt crisis was followed by a 29% rebound in six months.

Combining these historical experiences together with an EPS rebound expected for Q4 partly explains why Goldman Sachs and Soc Gen have released encouraging targets for the S&P 500, at 3’200 and 3’500 respectively, i.e. 25%+ above current levels.

 

1-year P/E forward ratio

 

 

Macro

German business confidence plunged the most in almost three decades, IFO expectations at 82 vs 93.4 consensus while Philadelphia Fed Business outlook scrambled down to -12.7 vs 8 consensus, crashing by most on record to 9-year lows. That is the weakest level since September 2011

Jobless claims are rising, and we strongly believe this is just the beginning.