A long overdue dose of reality
We have been communicating with you our views that there is a massive disconnect between Wall Street and Main Street. Since the lows of March 23rd, we have been very busy conveying and defending our beliefs that the fastest recovery in history was unsustainable. We remained steadfast in our belief that the short-sighted optimism which propelled markets would eventually meet reality.
On Wednesday June 10th, 2020, the markets finally got a long overdue dose of reality. The Dow Jones Industrial Average plunged 1861.82 points or 6.9%. The S&P 500 slid 5.9% while the NASDAQ Composite dropped 5.3%. In Toronto, the S&P/TSX lost 813 points or 5.1%. We believe that there is more to come on the downside. That’s not to suggest for a moment that we will not have up days through this bottoming process. Volatility will remain extremely high throughout the next several quarters. The VIX Index commonly referred to as the fear index jumped from 26.46 on Wednesday June 10th to 43.38 on Friday June 12th, an astounding 64% increase.
On the day of the webinar May 21, 2020, I gave 10 key reasons why we thought the market would retest the lows. Below are a few points from that webinar that we have updated.
1. There are now 36 million people unemployed in the United States, almost the entire population of Canada. The head economics professor at Harvard University said the other day on CNN, that there could be a 50 percent increase in the homeless rate in the United States.
In May, there was a surge in new jobs, which surprised the market with an increase of 2.5 million jobs. That still doesn’t remove the fact that there are still over 20 million Americans unemployed. The overall unemployment rate only fell from 14.7 to 13.3. That still remains the highest level of unemployment since the Great Depression.
2. The head of the Federal Reserve, Jerome Powell, stated that he now feels the economic downturn may last till May 2021. He also stated that he doesn’t believe that interest rates in the U.S. will go into negative territory.
In late May 2020, Powell said, “the loss of thousands of small- and medium-sized businesses across the country would destroy the life’s work and family legacy of many business and community leaders and limit the strength of the recovery when it comes.” (Financial Post).
Powell delivered a stark warning on Wednesday that the United States was experiencing an economic hit “without modern precedent,” one that could permanently damage the economy if Congress and the White House did not provide sufficient financial support to prevent a wave of bankruptcies and prolonged joblessness.
Mr. Powell’s blunt diagnosis was the latest indication that the trillions of dollars that policymakers have already funneled into the economy may not be enough to forestall lasting damage from a virus that has already shuttered businesses and thrown more than 20 million people out of work.
3. Rising global debt before the pandemic We were extremely concerned about high global debt levels with governments, corporations, and consumers. If we were concerned back then we certainly feel troubled in a much greater way today. The congressional budget office says the U.S. government’s GDP to debt ratio could hit 101% by the end of the year up from 79% last year.
In an article published on June 5th, 2020 entitled ‘Fed Vows Boosts Debt as Borrowers Cut Thousands of Jobs’, the truth revealed its ugly head. What the Feds were hoping for hasn’t happened the way that they had envisioned.Borrowing by top-rated companies shot to a record $1.1 trillion for the year, nearly twice the pace of 2019. Companies as diverse as Sysco, Toyota Motor Corp., international marketing firm Omnicom Group Inc. and movie-theater chain Cinemark Holdings Inc. borrowed billions of dollars -- and then fired workers. Sysco Corp. sold $4 billion of debt. Not long after that, the food-service giant announced plans to cut one-third of its workforce, more than 20,000 employees.
4. One of our biggest concerns is the reopening of global economies too soon. Many health experts around the world believe that the reopening plans are far too aggressive and will only set us up for a significant leap damaging second wave. It shouldn’t be too hard to share that view as South Korea, China, and Germany have reported an acceleration in new coronavirus infections after they took steps to ease their lockdowns.
A second wave of coronavirus cases is emerging in the U.S., raising alarms as new infections push the overall count past 2 million Americans. On Wednesday of last week, Texas reported 2,504 new coronavirus cases, the highest one-day total since the pandemic emerged. A month into its reopening, Florida this week reported 8,553 new cases -- the most of any seven- day period. California’s hospitalizations are at their highest since May 13 and have risen in nine of the past 10 days. More than 20 U.S. states are seeing a pick-up in virus cases and spreading cases in Beijing have also raised concerns of a resurgence of the pandemic. The travel ban between the U.S. and Great Britain could persist for months.
After a fierce rally sent global equities close to their pre-pandemic levels, sediment in markets has turned negative. Economic data across the board suggests that the global economy is still weak and there are no signs that international travel is returning to normal anytime soon. In our view Tom Essaye, a former Merrill Lynch trader who founded 'The Sevens Report' newsletter, confirmed our view in a note where he said, “there’s still a lot of uncertainty in this market, and we would not be surprised if the pullback that started last week is 10%-15% in its entirety".
We believe the overzealous sense of optimism will continue to meet reality in the coming weeks and months. One of Sir John Templeton’s famous quotes was, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” In today’s environment, the stock market may also be intoxicated on hopium.