Two notes from Cornerstone Macro focus on the implications of President Trump’s announcement of halting all travel to with Europe for 30 days. In the first, “Hunker down (March 12)”, the firm says Trump’s speech implies the US government is acting in line with what the rest of US society is doing: hunkering down as it is now clear that significant parts of the economy are likely to practically grind to a halt. Furthermore, says CorMac, it is clear there will be no US fiscal stimulus for now, and while support for such measures may grow, how large it might be, and what form it may take is difficult to judge right now.
In the second, “Fiscal stimulus isn’t around corner (March 12)”, the firm says if a US fiscal boost isn’t imminent, markets have a good deal more downside ahead. The problem for policymakers is that economic data is nowhere near close to matching the markets for speed, so it is not possible to know where to focus government assistance and by how much, says CorMac. Given this, broader fiscal stimulus is the likelier format, but only after a lot more pain will the political will get there, says the firm. CorMac says it’s impossible to model what the “fair value” of the market is given that there is ZERO clarity on how long these issues will last and when and what kind of fiscal stimulus will occur. In the meantime, warns the firm, it very much believes that stocks bottom when there is a catalyst for change (i.e., a solution to the problem is found or started), and that catalyst appears further away than investors had hoped.
An additional third note ”Quick take: The Fed pulls out the liquidity bazooka (March 12)” Roberto Perli provides his quick take on the Fed’s liquidity measures announced today where they announced sweeping measures to address the functioning of the Treasury market, which had been compromised in recent days.
The latest global inflation report from Global Perspectives notes there is a natural tendency to focus on the consumer and business demand destruction that Covid-19 is wreaking around the world, but this is very far from the whole picture. Indeed, while some will attempt to infer from the collapse in US Treasury bond yields that the world is in the throes of a deflationary bust, says the firm, the reality is different and more complicated, with the probability of resurgent inflation on a 3- year horizon having risen materially. In assessing the global inflation outlook over the next 2-3 years, it is essential to examine the other factors at work, according to Economic Perspectives: first, investors should expect a series of ‘shock and awe’ fiscal responses from G8 countries in mitigation of the disruptive effects of coronavirus; second, investors should not overlook the unfolding profits shock and credit squeeze that could tip substantial numbers of companies into bankruptcy and shatter supply chains and networks; third, warns Economic Perspectives, Covid-19 brings closer the fracture of the entire macro-policy framework on which so many investment strategies rest.
The crude market has outdone itself, according to CreditSights, with all energy subsectors negatively affected by sliding prices triggered by the oil price war and the ongoing spread of the coronavirus. As a result, the firm has taken a closer look at its IG and HY E&P coverage given the new reality for commodity prices, stress testing credit metrics under $25, $35 and $45/bbl of WTI crude. Using the $35/bbl WTI scenario, 5 of 12 investment grade names under CreditSight’s coverage will have leverage above 3x on a hedged basis and 8 of 12 names are above 4x on an unhedged basis; most of the HY E&Ps would see leverage north of 15x. Nothing will be spared as crude price plummet and energy allocations are cut across the board, says the firm.
Buyers of 30-year Treasuries at sub 1% yields will likely suffer a painful fall from grace once history has run its course, warns INTL FC Stone’s Vincent Deluard. To that end, he has issued a report outlining six risks which threaten buyers. According to Deluard, panic buying and one-sided sentiment have made Treasuries extremely vulnerable to a vicious countertrend sell-off, sub 1% yields guarantee real losses over time, and Covid-19 will eventually disrupt supply chains and create inflation. Furthermore, he says the epidemic will likely accentuate bond unfriendly trends, such as de-globalisation and populism, investors that have poured $15 trillion into bond funds since 2007 will need to sell in the next decade, while the dollar might not necessarily retain its safe haven status.
MI2 Partners explain why the they believe the US response to the Covid-19 outbreak has been woefully inadequate and why, even allowing for lack of testing, markets will have to brace for a parabolic rise in US cases. Meanwhile, the firm notes the fact that VIX has been above 50 for a whole week, an unusual event that it says will unnerve even the slowest moving of fund managers and has prompted talk of “de-grossing”, when the overall size of portfolios has to be reduced. That process, says MI2, will only accelerate if the correlation between equities and bonds does not normalise and the asset classes cease moving in the same direction, as has been the case in recent days. The firm says investors need to be realistic and realise that as Covid-19 accelerates in the US together, the related economic slowdown, loss of confidence, high levels of corporate debt, and a developing liquidity crunch, are now combining to give investors a “perfect storm”. And just like the movie, it’s hard to see how this will end well, says MI2 – closing the markets maybe a sensible option.
Jefferies have released a note following a conference call with a former director of the US Biomedical Advanced Research and Development Authority to discuss remdesivir (RDV) and other drugs that may potentially inhibit Covid-19. The firm says the expert held a conservative view on the chances of hugely positive results for RDV in ongoing China Phase III studies, citing various preclinical and clinical results and no anecdotal positive news yet out of China – but did think it could add modest benefit. For its part, Jefferies thinks RDV could have benefit but mostly for patients early in disease onset and lower viral load. The firm says Phase III test data for RDV might come early April or sooner, and it believes even a marginal benefit of 10-20% would be a “success” given the large global unmet medical need. Jefferies retains a “buy” rating on RDV producer Gilead Sciences.
Cornerstone Macro’s energy team says that their new base case calls for low $30s Brent in 2020 and high $30s Brent in 2021 (annual averages) and forecast ~2 Mb/d inventory build in 2020 and a modest draw in 2021 based on the assumption that Saudi Arabia and Russia both raise production, while oil demand falls ~1 Mb/d y/y in 2020. That draws them to the conclusion that it will take roughly two years of low prices for shale to decline enough to rebalance the global oil market, that is, unless Saudi Arabia or Russia gives in to low prices. This is unlikely, say Cornerstone. The report says this could be further compounded by the fact that the EM oil demand tailwind fading, and conclude that it’s not hard to add up to 2009 type oil demand declines, despite the comparatively healthier global economy today. Looking further out, assuming low prices sustain through 2021, the middle of the decade is potentially exciting / setting up for a price spike.
With volatility in markets remaining high, the latest report from Longview Economics sets out to gauge the potential path of future price action as two, and possibly three, economic shocks play out in the global economy. The firm says given the recent violent moves in indices such as the S&P500 cash index, it is instructive to note the typical price action of markets after sharp 10% or greater sell-offs/crashes. To that end, Longview has analysed all those crashes since the late 1970s, a total of 15 sharp pullbacks, to assess how the stock market typically behaves after one of those initial waves of selling. The firm finds that after the initial wave of selling, the probability of a later retest of those initial lows is high. Longview warns, however, that it is rare that this initial retest significantly breaches the intraday lows of wave one.
The negatives of falling oil prices outweigh the positives for the US economy, say Ned Davis Research. That’s because of the damage lower prices will have on the US energy sector. NDR have analysed the impact of this using the the mining employment multiplier. They found estimates of this multiplier that range between 3.9 and 5.9, depending on the source and methodology. That means that each mining job supports as many as six jobs in other industries. NDR then modelled potential job losses for the sector, based on previous oil price shocks, to then come up with an estimate of total jobs lost to the economy overall. The result? Job losses of between 7-10% of the total jobs created in the economy in 2019.
US bank stocks have been hit hard recently as the widening of Libor-OIS spreads has raised concern for potential credit and systemic risks in the sector. But as Renaissance Macro Research’s Howard Mason points out in a note published yesterday, the operating regime of the Federal Reserve has evolved meaningfully since the financial crisis, and even since the spike in repo rates last September. So, investors should update the indicators they use to make more informed judgements of systemic risk in the sector. Mason says one of the most important of these relevant indicators today is the SOFR-IOER spread. This spread compares rates in the private market for secured (‘repo’) loans with the rate received by banks for making unsecured loans to the Fed through reserve balances in excess of those required by the minimum reserve requirements of a fractional banking system. What this spread suggests to Mason now is that there’s no problem with the ‘plumbing’ of the financial system: money is moving properly to where it needs to be.