By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
It is ironic that the SP 500 index soared 12% the week before Easter, its best performance since 1974, while the world’s biggest economies remain in lockdown. This is a testament to the sheer power of bear market rallies as the epic fiscal/monetary policies enacted by the US Congress/White House and the Federal Reserve. The plunge in the Volatility Index from its 86 peak in March to the mid-40’s as I write is a potent signal that global capital markets, despite the surreal zeitgeist de jour, are no longer as dysfunctional as they delve into the depths of the pandemic panic.
Dr. Anthony Fauci’s cautious optimism on the Covid-19 outlook and the OPEC Plus pact to cut output by 9.7 MBD are also metrics that reinforce bullish sentiment in the financial markets. Yet all is not hunky dory in this best of all Panglossian worlds. A world in which the Uncle Sam 10 year note trades at 0.74 basis points is a world not predicting a V shaped recovery.
It is impossible to forecast second quarter earnings, which could well fall 15-20% in the US. This suggests the SP 500 index prices in a relatively quick recovery in corporate earnings, an assumption that the “virus curse” may not permit. Goldman Sachs estimates dividends will fall 25% from 2019 levels and stock buybacks will fall to $340 billion, well below the post-Trump tax cut highs of $800 billion in 2018. Stock buybacks are a major pillar of the bull market on Wall Street and a major fall in buybacks is inevitable. Companies that benefit from the largesse of the US Treasury. Boeing, Delta, American Airlines have already suspended their dividends.
My strategy in the past month was to sell put options on stocks with stellar fundamentals (Microsoft, Google, AbbVie) and fortress balance sheets to take advantage of epic volatility in the stock market. While energy and financials are the Cinderella sectors of the US stock market, they are “cheap” for sound macro reasons. I prefer to invest in enterprise software, AI/robotics, communications services and, of course, biotech/healthcare.
Gabriel Garcia Marquez once wrote about love in the time of cholera but humankind awaits a magnum opus on investing in a time of coronavirus – the ultimate surreal, magic realism moment for a world that has only read about the Black Death and the Spanish flu.
I am relieved that the US Dollar Index is below 100 and once again inversely correlated to the performance of risk assets on Wall Street even as volatility in the fixed income and foreign exchange markets has declined. This means the Federal Reserve’s swap lies with global central banks have averted (for now) a US dollar funding crisis, which would have been catastrophic for the capital markets and the global economy. After all, US Dollar Index was 101 in March and I had an eerie déjà vu from the months after 9/11 and Lehman Brother’s closure. It is also reassuring to see the Euro rise from 1.0630 to 1.0950 as well as the bounce back in the Aussie dollar and sterling (great to see Boris Johnson out of ICU and recovering). I consider sterling the most undervalued G7 currency and I am a happy buyer in the 1.18-1.20 cable range, though I confess I was alarmed to see Britannia trade down to 1.14 on March 21 when all seemed lost amid financial Armageddon.
Strange to see gold once again positively correlated to the SP 500 index, as its 4.1% rise last week suggests. I do not recommend new buyers chasing Auric at $1695. Of course, gold’s momentum is higher but I would enter on any correlation, ideally near last week’s lows at $1640.
I doubt if the OPEC Plus output cut will significantly move Brent above $35 or West Texas above $26. Economists estimate the scale of demand destruction in April at 20 MBD and the planet faces the mother of all supply cuts. Dr. Copper? The red metal might have a doctorate in economics but not in immunology.