Friday, March 27, 2020

Maybe it's not a pandemic after all

For about 4 weeks, beginning in late February, stock markets around the world faced the growing realization that the virus that originated late last year in China (AKA coronavirus, covid-19, Chinese virus, CCP virus, and Kung Flu) might prove to be a global pandemic that could kill tens of millions of people within the span of several months. Epidemiologists frantically revved up their models to calculate how fast it might spread and how many lives might be affected. Geometric growth, it was noted (e.g., a doubling of cases every 2 days, as many feared) gets you from 100 to a million cases in less than 2 weeks. Yikes!

The peak of the prediction frenzy probably occurred around the time I turned on the TV and saw California's governor, Gavin Newsome, declare (on March 10th) that in the absence of strong countermeasures, 25.5 million Californians could contract the covid-19 disease within the next 8 weeks, resulting possibly in a million deaths and many hundreds of thousands of seriously ill citizens flooding California's hospitals. Obviously, as he and many other governors, presidents, and prime ministers around the world concluded, something had to be done—and quickly—to "flatten the curve," to delay the spread of the infection in the hope that therapeutics and vaccines could be developed, and to avoid dangerously overcrowding hospitals in the meantime. The result was the rapid onset of shutdowns, lockdowns, closures, and quarantines that caused economic activity around the globe to plunge almost overnight. Meanwhile, the media's anti-Trump bias and love of all things terrifying combined to fan the panic.

Perspective: After at least one month on the job, this killer disease has resulted in the deaths of only 85 Californians out of a population of 40 million. Since the normal flu season began last October, the CDC estimates that as many as 45 million Americans have come down with one form or another of the flu, and roughly 45,000 have died from complications of the flu. That works out to about 250 deaths per day. In all of the US, and for the year to date, covid-19 has been tied to only 1700 deaths. Simply put, this is not a pandemic, and is very likely not going to become one, especially given the draconian measures that have been imposed across the country to date.

Nevertheless, pandemic panic sent interest rates into free-fall, stock markets entered bear market territory in a matter of days, corporate bonds (especially those issued by oil producers, who faced near-extinction as plunging demand caused oil prices to return to collapse) cratered, and fear and panic resulted in a sudden and unprecedented demand for money and safe assets. Fear and panic, as measured by the Vix index, reached a peak in the mid-80s on March 16th, a level last seen at the height of the 2008 global financial market meltdown, when investors feared the imminent collapse of global markets and an extended global depression.

And now here we are, just 11 days after max panic, and the stock market is up almost 14% from last Monday's low.

What is driving the sudden onset of optimism, at a time when global covid-19 cases are on their way to 600,000, global deaths are almost 27,000, and Italian and Spanish deaths are more than 4 times China's deaths? Ah, you might say, the answer is easy. It's the passage this week of a $2 trillion US virus rescue plan, coupled with central banks' massive injections of liquidity. Maximum fiscal stimulus and maximum monetary stimulus surely have saved the day! (No doubt markets are also looking forward to Spring weather in the Northern Hemisphere, since that will most likely render the virus less potent.)

But you might be wrong. Fiscal and monetary "stimulus" doesn't send consumers out en masse to work and spend as if nothing had happened; stimulus surely doesn't cure the flu. Fiscal stimulus of the sort cooked up in the Senate only works as a backstop for all those who have been laid off, locked up, and shut down. Monetary "stimulus" only ensures that all those who want the safety of cash can find it, and all those who fear the onset of a global credit collapse can worry less. The virus rescue package is like a strong pain reliever, but not a cure.

What is beginning to make a real difference is the growing realization that the covid-19 virus is not nearly as deadly as the early projections suggested. That, and the rapidly growing list of therapeutics—led by chloroquine—and the accelerated development of vaccines and the fact that covid-19 test kits are on the verge of being distributed by the millions. The private sector really is coming to the rescue, and the media hype is being eroded by the reality on the ground. Dr. Birx herself is coming to this conclusion.

The shutdowns have certainly helped "flatten the curve," but it's impossible to purge this virus from our shores. Sooner or later most people will be infected, as has happened with nearly every new virus.

What we really need right now is to recognize that this virus is not a pandemic or a mass killer. It's probably more like an unusually nasty flu. We need to lift the economic shutdown as soon as possible and get back to work. Trump is right.

Following is a collection of updated charts which track the financial progress of what I believe will become our national nightmare, from which we will most likely wake up soon.

Chart #1

As Chart #1 shows, we reached peak panic on March 16th, and stocks bottomed a few days later (March 23rd). Since then the S&P 500 is up almost 14%. The Vix index has backed off from its eye-popping highs, but remains very elevated as stocks see-saw daily. I'm guessing the market will remain very nervous for at least another week or so, but eventually we'll see prices moving higher and the Vix moving lower.

Chart #2 

Chart #2 shows a macro definition of money demand: the ratio of M2 to nominal GDP. I've estimated the GDP number for the first quarter, and it is a conservative estimate. What stands out is the incredible surge in the demand for money and money equivalents relative to income. It's a replay of what we saw in the wake of the 2008-2009 Great Recession. This is likely to persist for awhile and increase further as nominal GDP is likely to drop significantly in the second quarter. When the market wants tons of money, central banks are compelled to supply it, lest disaster ensue.

Chart #3

Chart #3 shows another measure of money demand: the 3-mo. annualized growth in the sum of bank savings and demand deposits. There's been a literal explosion in the demand for safe money in recent weeks.

Chart #4

 Chart #4 shows the spreads on 5-yr Credit Default Swaps, which are a highly liquid and timely indicator of the market's concerns about the health of corporate profits. Peak panic saw these spreads soar, but they fell sharply in the wake of the Fed's announcement of massively accommodative monetary policy and a 100 bps cut in short-term interest rates. The Fed is doing the right thing.

Chart #5

As Chart #5 shows, the demand for 3-mo. T-bills has been so intense that their yields have gone negative (i.e., they sell at a small premium to their face value). By cutting the rate it pays on excess reserves to near-zero, and by stepping up its purchases of notes and bonds massively, the Fed is effectively supplying massive amounts of T-bill equivalents to the market in the form of the bank reserves it uses to purchase securities from the banking system. This is the right thing to do in a panic. 

Monday, March 23, 2020

Chart updates

Stocks made new lows today, but fear is receding. So far, my guess that last Thursday marked the worst of the crash seems to be holding up. The Vix has peaked, but stocks have yet to bottom, which calls to mind what happened in the 2008-9 period, when the Vix peaked months before stocks bottomed. I'd like to think th. On the margin, things continue to improve. The news has become less bad: there are now quite a few therapeutic drugs available, testing is rapidly ramping up in the US, Italy's new daily cases appear to be declining, the US shutdown has been extensive (and painful), mortality rates are trending lower than feared, the Fed has pulled out all the stops, and Congress will likely soon approve a massive and reasonably-effective stimulus and aid package.

Chart #1

In Chart #1 we see that the Vix hit a peak of 80+ last Thursday, whereas stocks have fallen further since then, This is not an all-clear signal, but it is somewhat reassuring. Panic is subsiding, and concrete solutions are being implemented.

Chart #2 

Charts #2-4 show what is arguably the best measure of equity market capitalization. Note that this calculation comes from Bloomberg, and it excludes ETFs and ADRs in order to avoid double-counting (it is also in dollar terms). Note also that although the current crash has been extremely rapid and steep, it is still noticeably less, on a percentage basis, than the financial market disaster of 2008-2009. Back then the world feared the collapse of global financial markets and a global depression. At one point in late 2008, one Wall St. firm calculated that credit spreads were priced to the expectation that something like 25-30% of all US corporations would be out of business within a few years. We are NOT talking about that kind of destruction this time, thank goodness. This virus is almost certainly not going to wipe out a huge chunk of the world's population.

Chart #3

Chart #4

UPDATE: I highly recommend this letter from the Association of American Physicians & Surgeons to President Trump, dated March 21st. Very impressive and encouraging!

UPDATE: as of 12:30 EDT. My forecast above that "we'll see the bottom in stocks sometime in the near future" looks to be coming true just two days later. Here's an updated chart:

Chart #5

Thursday, March 19, 2020

We've probably seen the worst

My sense is that yesterday marked the extremes of panic, despair, capitulation, short-covering, and anguish.

As emotions cool, even as covid-19 cases soar and deaths rise, we are beginning to see the light at the end of this tunnel. There are several drugs that are now available as therapeutics, thanks to Trump twisting the reluctant FDA's arm. Trump knows, and everyone does also, that maximum pressure needs to be applied to the Saudis and the Russians to encourage them to end their mutually-destructive crude oil price war. Even as Italian virus cases soar and mortality rates exceed what happened in China, the numbers in the rest of the world are becoming more realistic. High fatality rates appear to reliably coincide with colder climates, older and sicker populations (99% of the Italians who died from covid-19 deaths had at least one other infirmity or illness!), populations with high rates of smoking, and populations with centralized healthcare systems. Mortality rates in Germany, the US, Germany, Japan, France, the UK, Canada, Australia, Switzerland, So. Korea, and Singapore are much lower. All mortality rates are most likely overstated in any case, since it appears that only about half of those infected with coronavirus show symptoms, and those are the only ones that tend to be tested.

If nothing else, the extreme measures already adopted by most of the U.S. and the rest of the world will almost certainly result in a slower progression of contagions in the weeks to come. Testing kits—essential to effectively control the disease, but tragically lacking in most of the US until recently—are now being widely distributed.

I'm not saying this is the absolute bottom. The Vix index has probably hit its peak, but that doesn't guarantee that risk assets have hit their bottom. The Vix peaked in October of 2008 but the stock market didn't hit bottom until early March '09. Oil prices surged almost 25% today, but they remain extremely low. The dollar continues to march higher, and that puts pressure on all commodity prices and most emerging market economies.

But the anguish that permeated everything yesterday seems to have faded to an important degree today. On the margin, the news is no longer uniformly bad; there are pockets of relief and glimpses of improvement beginning to show up here and there.

Some relevant charts:

 Chart #1

 Chart #2

As Charts #1 and #2 show, the Vix index has reached a high that is just shy of the worst levels we saw at the height of the 2008 global financial crisis. Back then, many thought that we were on the edge of the abyss, about to witness the collapse of the entire global financial system, coupled with a global depression. Can a little tiny virus be worse than that? Chart #1 shows that the market has effectively given up the gains it registered over the past three years. Three years of record-setting profits, decent growth, rising prosperity, lower taxes, and record-low levels of unemployment—all for naught.

 Chart #3

Chart #3 highlights the price action of the S&P 500 over the past six months. It also shows (bottom bars) how trading volume has soared as prices have plunged. Record levels of panic, record levels of trading, and plunging prices are the hallmarks of a panic-driven market, and they are also typical of bottoms. Let's hope this is as bad as it gets.

 Chart #4

Chart #4 shows the spreads on high-yield, energy-sector bonds as of yesterday (Mar. 18th). We've never seen worse, and it is directly a function of the enormous decline in oil prices, which have created near- fatal conditions for most of the world's oil producers. But thanks to a 24% gain in oil prices today, we've probably seen the high-water mark for energy sector credit spreads. Importantly, Trump today announced that he is going to "apply pressure" to the Saudis and the Russians, in order to force them to cut their output.

 Chart #5

Chart #5 shows 10-yr Treasury yields (red line) and the level of the S&P 500 index (white line). It looks very much like Treasury yields have been leading the stock market. If that is indeed the case, the big jump in yields over the past several days suggests the stock market is likely to experience some welcome relief in the days to come. 10-yr yields have traditionally been a good barometer of the market's degree of confidence in the outlook for the economy. Most commentators will probably attribute the rise in Treasury yields to the market's expectation of huge federal deficits being funded to pay for fiscal "stimulus" plans. I have yet to see anyone of late come up with any fiscal plan that looks genuinely stimulative. Sending checks to everyone does nothing to change incentives to work or to keep idle workers on the payroll. I would get excited about a payroll tax holiday. In any event, it's just as likely that the market is reading the virus tea-leaves and concluding that the pandemic hype has been overblown.

 Chart #6

Chart #6 shows the spread between 10-yr and 30-yr Treasuries. Rising spreads are typical of economies that are growing and healthy. I think this chart reinforces the argument that the market is beginning to look across the valley of despair, and anticipating better times ahead.

 Chart #7

One troubling fact remains: the strong dollar. As Chart #8 shows, the strength and weakness of the dollar tends strongly to coincide with the ups and down of commodity prices. The dollar is now at an 8-year high, and commodity prices are uniformly weak. (Note that the dollar is plotted using an inverted scale.) That's bad news for emerging market economies, and it's even pulling down the price of gold—which is remarkable given all the bad news that's out there. For that matter, gold stands out among all commodities for its resistance to the strength of the dollar. Gold investors should be wary.