SpringTide Weekly #72: zombies, coronavirus and the great disconnect

Equity graph

SpringTide Weekly #72: zombies, coronavirus and the great disconnect

Below are some market highlights from the last week and a few things we are working on.

MARKET RECAP

The spread of the coronavirus pandemic accelerated last week as the U.S. set a daily record on Friday with 45,255 new cases, according to data from Johns Hopkins. Total cases in the U.S. now exceed 2.5 million, with a significant number of new infections occurring among younger Americans. Texas rolled back some reopening plans with bars closing and restaurant capacity being reduced. Similar rollbacks are being initiated or proposed in other economically significant states including California and Florida. While there have been some contradictory reports, hospital and ICU capacity appears to be running low in the most affected counties.

The Federal Reserve’s Dodd-Frank stress test results announced on Thursday included a moratorium on large bank buybacks until the end of the third quarter and a capping of dividends to second quarter levels. The curbs on bank payouts were the result of a more detailed sensitivity analysis of three potential recovery trajectories from the coronavirus crisis, all of which presented possible economic scenarios that were worse than the worst-case scenario laid out in the Fed’s initial stress test.

According to offshore betting website PredictIt, the odds of Joe Biden winning the U.S. Presidential election in November rose to 62% last week, a new high.

Stocks declined on the week. The S&P 500 was lower by 2.9%. The VIX closed the week at 34.73. Crude oil ended the week at $38/barrel, but rallied strongly today.

Gold ended the week at $1,785/ounce after hitting an almost eight-year high on Wednesday. Gold is now near or at an all-time high in every major currency.

COVID-19 UPDATE

We flagged that we were concerned about a potential acceleration later in June and unfortunately it has materialized. Over the last two weeks we’ve seen new daily cases ramp dramatically, particularly in Florida, Texas, Arizona and California.

The real fear was that we would echo the April ramp which saw cases lead deaths, but so far that has not materialized, likely due to younger people getting infected.

It is, however, too soon to celebrate; hospitalizations are rising, albeit at a relatively slower rate.

At the global level, we continue to set new records for daily new cases. According to the WHO, 189,000 new cases were reporting on Saturday. Nearly two-thirds of those were in South and North America. For most of the world this is still the first wave.

THE GREAT DISCONNECT

A few cautionary signs for investors betting on a V-shaped recovery. First, total corporate profits (i.e. not per share) vs. total market capitalization (source: The Felder Report).

S&P 500 profit margins (yellow line) vs. price (blue). (Source: Bloomberg)

Truck tonnage vs. the S&P 500. (Source: ATA)

We shared this chart previously with April data. Here it is updated with May Durable Goods data. A bounce? Yes, but hardly a “V”.

Similar situation with Johnson Redbook Retail Sales.

THE ZOMBIES ARE COMING

We can’t help but notice the growing pushback on the massive intervention by central bankers and other policymakers in recent months by the mainstream media. Whether justified or not in the short-term, intervention has long-term consequences. One example of this is the rise in zombie companies.

Definition courtesy of a Bank for International Settlements white paper from 2018.

According to Axios, almost 20% of all U.S. companies are now zombies.

More from Axios: in short, one side effect of central banks keeping rates low for a long time is that it keeps more unproductive firms alive, which ultimately lowers the long-run growth rate of the economy.

This clip (click image for link) captures the growing frustration with the heavy-handed approach the Fed has taken in recent years. And this is CNBC, not some obscure tin-foil-hat blog or Reddit thread.

On this note, here is Bloomberg anchor Alix Steel calling attention to the topic.

This is what Alix is reacting to: the recently released list of companies whose debt the Fed is buying as part of its corporate bond buying program, termed the Secondary Market Corporate Credit Facility (SMCCF). It is not clear to us why Apple, a company with roughly $200 billion in cash, needs federal support. (Source: New York Fed)

We’ll repeat something we shared in an earlier SpringTide Weekly: maybe the only risk to stocks is that the disconnect [between the economy and markets] becomes so great it becomes a political risk.

If that’s true, bulls should hope that polls and betting markets are wrong about the election.

 

WEEKLY RESEARCH RECAP

Interesting research we read, listened to or watched:

  • Bloomberg: Powell’s Ready to Play the Fresh Prince of Bubbles: Link
  • FT Alphaville: The Zombie Rally: Link
  • Why a small town in Washington is printing its own currency during the pandemic: Link
  • Nucleus: The Virus Bubble Has Arrived. How Much Bigger Can it Get?: Link
  • Credit Writedowns: Hyman Minsky and asset price inflation versus consumer price inflation: Link
  • WaPo: Here’s one more economic problem the government’s response to the virus has unleashed: Zombie firms: Link

 

Sincerely,

SpringTide Investment Team

 

IMPORTANT DISCLOSURES

SpringTide Partners, LLC is a Registered Investment Advisor with the state of Illinois and other states jurisdictions where required. Registration with the SEC or any state securities authority does not imply a certain level of skill or training. All information contained herein is for informational purposes only and does not constitute a solicitation or offer to sell securities or investment advisory services. All investing carries risk including risk of principal loss. All statements made on this website are opinions of SpringTide Partners, LLC and are subject to change. SpringTide Partners, LLC assumes no responsibility for the accuracy of the data included. Statements made on website shall not constitute investment advice.