3/9/2020: 11 Year anniversaries - Epic bottom & Epic plunge

Screen Shot 2020-03-09 at 3.58.40 PM.png
Screen Shot 2020-03-09 at 3.10.01 PM.png
Screen Shot 2020-03-09 at 3.10.48 PM.png

Well, today was not a fun day in equity markets. Today was one of those days where every possible uncertainty was weighing on the minds of investors, here and abroad. I’ve seen some serious drawdowns over my career but the current move’s swiftness has truly been historic. Am I the only person that thinks it’s ironic we had this historic drawdown day on the 11th anniversary of the March 9, 2009 bottom around 670 on SPY?

I’ll get right to the question everyone has on their mind: Is the cycle over and the recession here?

Answer: I don’t think so but I cannot be stubborn.

History says the markets often go through periods of turmoil and big corrections happen and are to be expected. The real test of a bull market correction and the beginning of a bear market and recessionary drawdown tend to come from breaks of the long term uptrend. The real madness tends to begin once the break occurs on a monthly basis. Why monthly? Because anything can happen on a daily or weekly basis but when we see a slower time frame start to breakdown, we have to accept there could be even more pain coming and stepping aside to some degree may be prudent. We are trading around the long term uptrend line so how we close this month will help me decide what kind of market we could be in for the rest of this year and next. Please understand though, this virus will run its course sometime over the next 3-6 months and commerce will snap-back the way it always does so we could see continued selling for a few more months followed by a realization this is a shallow recession and one that likely snaps back quicker than most.

Screen Shot 2020-03-09 at 3.45.40 PM.png

Yes, sentiment was extreme to the bullish side, there’s no disputing it and I have written and talked about it a number of times in blogs, Bloomberg interviews, etc. Here’s some trader/investor psychology:

  • Market sentiment is über-bullish and we don’t think we can lose money.

  • The market pulls back and dip buyers add more exposure and get rewarded.

  • The “buy the dips” mentality keeps getting reinforced with strong returns.

  • That breeds complacency & excess risk taking aka using margin, buying speculative call options, etc. An extreme amount of complacency is a very dangerous thing when it goes on for a period of time.

  • Proof of complacency: The number of option call buyers was at extreme levels a month ago. Let’s just assume, those people lost 100% of their money. I’m guessing they are no longer complacent.

  • The market falls, dip buyers grab some stocks but they keep falling, now people are trapped. That creates overhead resistance. There is a massive amount of holders at much higher levels just hoping they get closer to break even which keeps the upside capped for a while. For now we just need some stabilization to help calm fears.

  • Not being rewarded for multiple tries now puts investors back on their heels, that’s a healthier situation. People are absolutely on their heels right now.

  • Now we have investors and traders in “short rallies” mode and “don’t buy dips yet” mode. We are very close to being as extreme bearish as we were extreme bullish just a little over a month ago.

Screen Shot 2020-03-09 at 2.36.57 PM.png

Why did markets crash today? UNCERTAINTY

  • 10 Year Treasury under .50% - that’s scary

  • Should we even leave our houses at this point? The media is scaring people to death.

  • Stock markets hit the -7% halt circuit breakers this morning. That will make for scary headlines for investors when they watch the highly news and talk to their friends.

  • Crude oil collapsed ~30% and is off 47% from the highs to about $30 a barrel. American Shale producers are mostly profitable above $50/barrel. Russia has clearly decided they are willing to flood the market with oil to drive prices down in the hopes of putting American companies out of business. Saudi Arabia is no help to us as they lower prices to become the low price player around the world.

  • Crude oil crashing is also a sign of recession as economic activity slows.

  • Energy stocks absolutely destroyed. The XOP ETF, oil and exploration basket is now down -89% from the highs. The market is now pricing in a massive wave of bankruptcies. I have to believe, some of the most high quality energy companies with the strongest balance sheets are feeling this pain but licking their chops for buying assets at pennies on the dollar. There will be an enormous opportunity in energy stocks and energy bonds at some point .

  • I have confidence we will see some significant commodity-focused hedge funds and macro funds blowing up, one of the causes for this persistent selling. There’s clear full liquidations happening at this point.

  • Corona Virus-19 continues to get worse, more cases are being discovered each day. We will continue to see more cases as the number of tests accelerate. Italy has now announced a full-country quarantine to try and get a handle of the spreading.

  • Earnings recession - very few companies will come of our this slowdown unscathed but at this point we need to ascertain how much is already built into prices. Thus far, there’s only been small guide downs and if things accelerate to the downside, there will be further guide downs. The current market is clearly deciding these reduced earnings will continue and likely get even deeper in the red. If consumers live up to their reputation and do not stop spending as the market suggests, there will be a breathtaking rally once the recognition happens. We start to see earnings in mid April.

  • Interest rates - most rates are now close to zero. There’s clear panic in the air and a scramble for no yield bonds strictly for the total return potential and perceived safety. Just remember, when people just talk about bonds and making money versus offering yield, we will be ever closer to the bottom in rates.

  • Credit crisis - because of low rates created by the Fed, corporation have lathered up in debt and instituted massive and consistent stock buybacks. That’s great until the economy slows, cash flows slow and the company has to pay debt from weakening cash flows. So far, all credit spreads have widened(bad) and the most heavily indebted stocks are under the most pressure. This is a time to own the most high quality balance sheets you can. When the market over-reacts, they will shoot first and ask questions later on stocks that have poor quality balance sheets. Even the LQD ETF, investment grade bond ETF was down -2.4% today. So there’s clear risk that investment grade companies get downgraded and many companies see their debt rating lowered in general. Remember, when fear and crisis happens, the credit markets freeze up and access to capital becomes difficult. If you need to come to the debt markets and they are not open for business, your stock and bonds fall precipitously and shorts get aggressive.

My Problem Here:

I’m a huge believer in buying the defensive stocks in times of slowdown. It’s worked well for the last month even if these companies are still down less than the growth stocks. Here’s my problem: Many of these companies are highly sensitive to rates, called bond proxies so how does one get excited about a bond proxy with rates almost at ZERO?

Here’s my other problem: Most defensives, while being the beneficiary of money flows, are very expensive and have very poor growth profiles. Yes, expensive can get more expensive, particularly when buyers expect a major economic slowdown coming but buying a no growth, expensive stock with an average to poor quality balance sheet just because it has a decent dividend at a period of time when rates have gone straight down is a tough call to make. At some point, fears will abate and growth will trough and when that happens interest rates will rip right back to the drop off level around 1.5% and I doubt bond proxies will perform very well.

What am I focused on and buying/holding now?

With very few exceptions, it’s the quality factor that’s driving the portfolio. I’m focused on the innovators of key industries and consumer themes. I’m focused on quality balance sheets, revenue growth opportunities, strong cash flow generators, and solid capital allocators. Slowdowns hurt most companies but the best companies take advantage of slowdowns to take market share, make strategic acquisitions, and add to their competitive moats. It doesn’t mean the stocks won’t go down when the dominant trend is lower but it does mean they have sustainability and will likely come out of the slowdown even stronger. That’s my focus for now.