Stuck between the devil and the deep sea
The markets dynamics are so confusing and divisive that it is difficult to get a good handle on it. First the positives.
Please FORWARD this to your friends and colleagues - it's a FREE article.
Feel free to share this with others and on social media.
Or tell your colleagues and friends to sign up for free
The Fed is feeling more confident about the measures that it has taken since the outbreak of the pandemic. Fed Chairman recently said, “the Fed would like market conditions to dictate further Fed actions”.
It is now looking for a contraction of only about 15% for Q2 when only a month back they feared a contraction of 35%. The Atlanta Fed which was projecting a contraction of more than 50%, a little over a month back have revised their projections down to 35%. These are big revisions. It is understandable for the level of meteoric shock that the world has been hit with, there are no better econometrics model out there to give you a better analysis. So, based on an average of the above we can assume the economic loss output can be anywhere between 800 billion to 1.8 trillion dollars.
Unlike all other crisis situations, the response to this crisis has been very swift and far generous. Without going into all the various types of policy responses, we can estimate the authorities are creating a liquidity of 15 trillion dollars.
During the GFC in 2008, the Fed expanded the balance sheet from around $900 billion to $ 4.5 trillion. So, if we deduct $1.8 trillion from $15 trillion you can imagine the level of new money in the system. Now we should know why the stock market is so strong. The markets are swimming in a sea of liquidity.
Now the negatives.
A recent report in the FT says that with the governments support corporate debt in the US has reached over $10 trillion which is about 50% of the economic output. The response to any crisis so far has been to increase leverage. Whenever at good times the Fed tried to decrease the leverage the markets reacted violently to the downside and the authorities backed off.
The Dallas Fed president Robert Kaplan revealed a secret to the market. In an interview with Fox News he said, “If we all wore a mask, it would substantially mute the transmission of this disease, and the economy will would grow much faster.”
Probably it is true. With the freedom that Americans enjoy more than any other law-abiding developed countries in the world they just cannot agree on how important it is to wear a mask when necessary. Looks more like the US elections which is due in a little over 100 days and two weeks will be decided over a mask.
What is unique about the current situation is that the world was hit with a ton of bricks all of a sudden. The policy response that accompanied clearly masked the depth and severity of a problem that we have not seen in about 100 years. As we try to take stock of each issues going forward, we will have to face the truth.
One of the major themes we are facing is how various cycles play out. The structure and mix of occupations normally change over a period of time. Industries would shrink and disappear over decades or even centuries while others arose at a similar pace.
As we can see it consumer preferences are changing before our eyes, within months. This is giving rise to new industries and more efficient way of communication and transmission. Established companies are dying or trying to adapt to the new changes while new ones are establishing their foot hold.
While all this is happening, the pandemic holds centre-stage. There is a resurgence of COVID-19 cases around the world. Australia, where I live, previously considered a safe haven from the pandemic is now marred with a steep rise in cases in the state of Victoria.
Governors in some large states in US notably Florida and Texas have been very shifty with their policies on the pandemic. If there is a significant rise in deaths the country will be forced to take the path of another lock down which will be devastating. With that let’s look at the markets.
Equities
The relentless rise in the Nasdaq is probably masking the real situation in the overall markets. There are divergences everywhere which is a sign of topping.
The sentiment index is close to it highest recorded levels and the difference between the DSI of the S&P 500 to the volatility index is at the widest point too, meaning the market expectations are for the markets to continue rising while volatility remains low. The option traders are buying 2.2 calls for every one put.
It is very risky to be long at these high levels.
Bonds
Bonds rallied intraday on Friday but closed below the previous days close. The pattern is not that clear and may make a high above the Apr 22 high at 183^02 before turning lower. A move below 174^30 will be a sign that the upside pressure is over.
Euro
The short-term picture in the Euro is cloudy. The key level to watch on the downside is 1.1170.
Gold
The move up in gold on last Wednesday must have completed all major patterns in different time frames. Prices closed just under 1800 on Friday and will be interesting to see how it plays out this week.
Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.