I am in the middle of watching an entertaining interview of Mark Cuban by Larry McDonald on Real Vision right now. I haven’t got to the part to which I assume the title refers: “Mark Cuban — This Feels a Lot Like the Internet Bubble“. But, while I think the comparisons to the Internet Bubble are a little hyperbolic, what I was reading early this morning did scare the bejesus out of me. And it makes me wonder whether, in the midst of a massive economic downturn, we are seeing a liquidity-fuelled speculative mania. Some thoughts on that below
Where I am right now
Yesterday I was telling you that I thought it was time to re-evaluate the re-opening rally I called in late April. The gist was that while I sensed re-opening would be a catalyst for upside momentum in April, with fiscal and monetary support putting a floor on risk assets, the rally has gone too far now. Positive sentiment is as robust today as the negative sentiment I called out in April.
No sooner did I write this and the market surged yesterday to where the Nasdaq breached new highs and the S&P 500 erased all of its 2020 losses. This is bonkers in the middle of a recession.
There are only two possibilities then. Possibility number one is that the recession is now over. And in retrospect, the re-opening was the catalyst to recovery that the suspension of mark to market accounting was in 2009.
As a recap, the market was still in freefall in February and March 2009. In February, long-tern investors like Jeremy Grantham were telling people to pull the trigger and dip back into markets. But, he looks for value irrespective of momentum. And he’s always said he’s a terrible market timer. So, the market continued to fall. By the time we were near the bottom, Grantham was incredibly bullish because we were clearly in the overshoot phase of the bear market. Nevertheless, at the time, I expected momentum to carry the S&P all the way down to 450. But, momentum shifted. And when mark-to-market was suspended, and a week later, Wells Fargo posted bullish earnings, I knew we were off to the races. That was the bottom.
At the time, I called it “The Fake Recovery” because, while I recognized we had hit bottom, my bias was that there were still unresolved structural issues lurking in the background. Mind you, a lot of people still hadn’t recognized the turn, even by May. And I got a lot of flak for calling it. but, the reality is that I shaded my view toward my bias – which was sceptical of the recovery.
I won’t make that mistake here. I fully recognize that one possible outcome from the massive policy stimulus we are seeing is another ‘fake recovery’. And, let’s remember that the last ‘fake recovery’ was the longest expansion in history.
But, but, but…
At the same time, there is another possibility. And I have more sympathy for this outcome at present. And that is where the re-opening heralded the end of a short recession a-la 1980, but a second, deeper one is on the way, a-la 1981-82. And, as in the double dip recession from 1980 to 1982, the true bear market bottom is on the backside of the second recession.
That means the speculative fervor we see right now is a harbinger of another leg down, as we saw in late 2008 and early 2009. Back then, the credit cycle and the inventory cycle had yet to play out. And Q4 2008 ended up as the worst quarter we had in that cycle, with real GDP falling 2.16% in absolute terms.
Look at the news flow today, for example. Shale oil pioneer Chesapeake Energy is due to file for bankruptcy. And it’s likely that its FILO term loan holders will own the company. Yet, speculation in Chesapeake Energy shares is rampant, as it is in other bankrupt and soon-to-be bankrupt companies. Retail investors are leading the charge.
Investors are piling into stocks of bankrupt companies, wagering against a court process that routinely wipes out shareholders.
Car renter Hertz Global Holdings Inc., oil driller Whiting Petroleum Corp. and retailer J.C. Penney Co. are among companies that have seen their shares more than double in recent trading sessions despite being in Chapter 11 bankruptcy, a process that allows companies to keep operating while working out a plan to repay creditors.
[…]
Some of the rally in bankrupt shares might be attributable to short covering, when traders who have bet against a company close their positions by re-buying shares, lifting prices. But the rally could also be fueled by amateur traders, bored in lockdown and looking for a quick buck, using platforms such as Robinhood. The number of Robinhood users holding both Hertz and Whiting Petroleum shares surged after the companies filed for bankruptcy, according to Robintrack, a website unaffiliated with the stock trading platform that uses data to show trends.
[…]
The price hikes among the bankrupt include:
- Hertz, which climbed 95% since it filed bankruptcy on May 22
- J.C. Penney, up 167% since May 15
- Whiting Petroleum, up 835% since April 1
- Pier 1 Imports Inc. more than doubled in the last two trading sessions, though it’s still down 97% since filing for bankruptcy on Feb. 17
Companies that have begun planning for bankruptcy also saw their shares surge Monday, including:
- Chesapeake Energy Corp. jumped 182%
- GNC Holdings Inc. rose 106%
This is straight up bonkers.; it’s a speculative mania. And it will end badly.
That’s not to say that there is a mania in the overall market. But I still see the credit cycle ahead of us. And the question is whether fiscal and monetary support will be enough to see us through.
Bank stocks, particularly European bank stocks are the ultimate value stock measure because, as with the Wells Fargo earnings report in April 2009, that’s when we know the credit pain is at an end.
As for the overall market, according to Bloomberg, global equities are now trading at 20 times next year’s earnings. That’s the most expensive since 2002. And share price gains in this past month’s re-opening rally are entirely based on multiple expansion. Bloomberg says “earnings forecasts have barely budged since May.”
Finally, there’s this:
Speculative excess has surged to the highest in at least 20 years among U.S. options traders — and that’s a negative for stocks over the medium term, according to Sundial Capital Research Inc.
Traders established fresh bullish positions last week by buying 35.6 million new call options on equities, according to Sundial founder Jason Goepfert. That’s up from a peak of 28.7 million in February, when speculative activity was rampant, he wrote in a note Monday.
“Options traders make stunning bets on rising prices,” Goepfert wrote. “This kind of activity has a strong tendency to lead to negative returns in the S&P 500 and other indexes over a multi-week to multi-month time frame.”
Again, a lot of this is coming from retail investors piling into shares.
My view
I recognized early that the re-opening was bullish for risk assets. But I am not convinced the economic lift is durable, especially given the uncertainty surrounding the coronavirus pandemic and surrounding sustained fiscal and monetary support.
In my view, we also still have a credit cycle to face, with as many as 25,000 retail stores closing in 2020 in the US alone. Last night, I was listening to a German podcast, WDR 5’s ‘Das Echo des Tages’, and they were also talking about retail bankruptcies, centering the story on Karstadt/Kaufhof, which has announced it is closing 80 stores. Retail employees interviewed were hopping mad and in fear for their future. That won’t drive positive outcomes to Europe’s economic crisis, when German voters are told that transfer payments are going to Italy and Spain because of the coronavirus pandemic.
So, the re-opening rally in shares and oil prices is on shaky ground now. It has run too far too fast. Economic data can continue to support optimism through the end of June. But, the back half of the year will be more challenging, especially as post-opening earnings visibility becomes greater. And I suspect, this will be a catalyst for risk aversion.