What an incredible time to be an investor!; S&P 500 is up 4.5% over the past 15 months; Technical/momentum reasons for the sell-off; perspectives from Daryn Kutner and Doug Kass; New cases in Italy and the rest of the world drop; My coronavirus e-mail list

By Whitney Tilson

Tuesday, March 17, 2020
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1) It was another crazy day in the markets yesterday… It was the sixth consecutive day of the S&P 500 Index moving by at least 4%, the longest streak since November 1929. The S&P closed down 12% and has now fallen 29.5% from its all-time high less than four weeks ago. The Dow Jones Industrial Average had its second-worst day in its 124-year history. And the CBOE Volatility Index (“VIX”) fear gauge closed above its all-time high in late 2008.

2) My take on all of this: What an incredible time to be an investor!

I continue to put my “dry powder” to work on big down days like yesterday, mostly in the S&P 500 (to prevent conflicts of interest, I can’t buy any stocks we recommend in our various Empire Financial Research newsletters).

We’re only recommending one airline stock, however, so yesterday I took advantage of the collapse in this sector to buy a basket of six others. I also bought a basket of seven financial stocks this morning. I can’t predict how much further they might fall, but I’m confident that stocks like these will rally the most when (not if) the market turns.

In light of the many pieces of good news that I highlight below (e.g., a drop in new coronavirus cases in the rest of the world, especially Italy, and the likelihood of fiscal stimulus here in the U.S.), I bought more of the S&P 500 on the open today.

Take this with a grain of salt, as I’ve been too early so far… but I think there’s a 50% chance that we’re within 5% of a bottom, and a 75% chance that we’re within 10% of the bottom.

3) I hope you’re sitting down… Through yesterday’s close, the S&P 500 is up 4.5% (with dividends) since its 2018 low on December 24 of that year. That’s right: we’re roughly back to where we were less than 15 months ago – and far above where we were 10 years ago – as this chart shows:

4) This front-page story in today’s Wall Street Journal, Why Are Markets So Volatile? It’s Not Just the Coronavirus, captures why I think much of the sell-off may be due to technical factors and out-of-control computers rather than a rational assessment of how long the coronavirus crisis might last and how long it will take to recover from the damage – which is music to my ears. Excerpt:

Since the mid-February market peak, the Dow Industrials have closed more than 1,000 points lower on six trading days and rebounded at least 1,000 points four times. Adding to those moves, and potentially hastening them, are technical factors that have little to do with how investors feel about the outlook for companies, earnings and the economy.

In a dramatic shift since the financial crisis, the market today is dominated by computer-driven investors whose machines react to a series of technical and other factors, as well as by more-traditional investors who rely on reams of fast-flowing data. On many days, forces such as the market’s volatility and momentum, derivatives activity and the market’s liquidity – how easy or difficult it is to get in and out of trades – can help drive trading.

In earlier times, when trading was dominated by fundamental investors who scoured balance sheets, studied goods prices and tried to reckon a company’s future profits, market volatility figured in to some extent, but not in any defined way. Now, for many traders a stock is simply a thing that moves, whether the company makes shoes or airplanes or frozen pizza. And how much a stock moves—how sudden and sharp are its swings – is a factor as important as any other in whether to buy or sell it.

5) Michael Batnick, Director of Research at Ritholtz Wealth Management, posted some interesting data on the average S&P 500 returns over different time periods based on how far the index is from its high:

And in his next chart, Batnick shows the worst returns ever, commenting, “Stocks can go a lot lower over the short-term, but over the long-term, the situation starts to improve dramatically.”

6) A friend forwarded me this e-mail from Daryn Kutner, the CEO of Olivetree, who thinks we may be near a bottom:

Are we there yet? Quite possibly:

  1. Systematic and vol strategies are both at their lowest equity exposure since the global financial crisis. JP Morgan Chase is suggesting they are now actually net short.
  1. The Bank of America March Fund manager survey showed its biggest month-over-month drop in global equity allocation on record.
  1. Forget absolute VIX levels – it has never been this inverted … . now more than 50 vol points between two and eight months.
  1. Yesterday yields rallied and stocks fell. Let’s be clear: the Treasury curve has been ahead of the game throughout…
  2. REITS got smoked yesterday. This has been the number one hiding place for investors, [along with] utilities, for months. This suggests it’s now all about liquidating even the “good stuff.”
  1. The same applies to M&A spreads – it’s always the last place banks cut risk, and these got blown out yesterday.
  1. None of the 3,000 NYSE stocks traded at an all-time high yesterday, for the first time in 30 years.
  1. The SPX 10-day realized vol is 5.7x UX9 (long-dated implied vol), meaning volatility will fall, or the market is still complacent, or long-dated vol is illiquid.
  1. Flows into ultra-short term debt ETFs are already at $5.7b for March, already the most ever for a full month.
  1. SPX volume yesterday relative to recent days and certainly vs. the moves was low. Exhaustion?
  1. Expiry later in the week could be a massive technical moment for markets, as Gamma positioning has driven so much of what’s taken place in the last two weeks. The 9-day VIX is 107.

7) My friend Doug Kass of Seabreeze Partners also thinks it’s time to be putting money to work, for many reasons he outlines in an in-depth report this morning, which he gave me permission to share:

Though This May Not Be ‘The’ Time to Buy, It May Be ‘A’ Time to Buy 

* The market outlook will be a function of economics and emotion — I am more optimistic of the outcome than most

* Uncertainties and, now panic, are reflected in uneven and inconsistent market swings on a daily and evenly hourly basis

* But, uncertainty is the friend of the long term and rational buyer

* And so will the Fed, our Treasury and our scientific community prove to be “healers” and shine

* A period of heightened volatility will likely be with us for some time and the daily news stream will continue to impact stock prices

* Short term trading opportunities are substantial – but given the spastic and unpredictable nature of stock prices, only the most facile and disciplined need apply

* Attractive intermediate term investment opportunities are multiplying with abundance

* We may have just hit (or are close to hitting) a generational low in bank stock prices

* My money is also on Amazon and Google

For several months I have thought that a “garden variety” market correction was in order.

Concerns Realized and Risks Have Been Exposed

My principal concerns were a changing market structure (ETFs and products and strategies that correlated to price momentum) which produced a potentially dangerous situation in which too many traders/investors were on the same side of the bullish boat, the weakening foundation of global economic and corporate profit growth, an abundance of complacency (“A Minsky Moment”) in which skepticism has left the room and that traditional valuation metrics were at the extreme (based on history).

Many of the aforementioned risks have now been exposed (and, arguably, have been discounted) reminding us of Warren Buffett’s quote (that I have mentioned on numerous occasions over the last year) that, “We [don’t] know who is swimming naked until the tide comes out.”

3/20 Is More Like 9/11 Than the 2007-09 Recession

While I initially wrote a series of posts that I thought the market was underestimating coronavirus’ impact, I did not envision the magnitude of the disruptive impact to which COVID-19 would have and, almost as significant, the efforts to curb its growth would have on businesses and economies.

As a result, I failed to anticipate the magnitude and swiftness of the market’s decline since mid-February. That decline was not “garden variety” as I initially projected.

Yesterday, the major market indices declined in percentage terms that were similar to daily percentage declines in 1929 and 2008 – two periods in time that we were in The Great Depression and The Great Decession.

No historic event rhymes with today’s tragedy. The Great Decession of 2007-09 was a system wide breakdown not a health threat. 9/11 was a one day event and the threat lingered for some time. Similarly, the fear of a spreading of COVID-19 will linger.

Swift Policy and Preventative Moves to Address and to Attack COVID-19

The good news over the last three days is that, as a nation, our government is attacking coronavirus with all the emergency, financial and health power that is possible. As well, our businesses are making aggressive moves to contain coronavirus. But, most importantly, the Federal Reserve and our Treasury are moving to unclog the transmission of credit. They may even err on the side of overreacting.

While the next 1-2 months will be filled with growing headlines of the rising spread of coronavirus in the country, the aggressive efforts now being implemented (in policy and health), in the fullness of time, will likely flatten the curve and defeat the virus. I am very confident that our scientific community will swiftly discover effective testing, antivirals (that could directly act on the virus), develop antibody-based prophylactics (Regeneron) that protects the affected, the development of therapeutics and other treatment tools (which will materially improve diagnostics), get people into quarantine and use the aforementioned therapeutics to help those that are inflicted and contain future outbreaks.

The sense of urgency is growing and has intensified in the last few days – we need “shock and awe” and I believe we are going in this direction.

I am also confident that our Fed will effectively use their tools to unclog disruptions in the commercial paper market and in other areas of credit transmission.

A One-Time Event?

The bad news is that we will likely be in a recession over the next two quarters (in which real GDP growth will likely exhibit mid-low digits, negative declines, year over year). We are no longer hiding from the health and economic risks, almost as important, mass behavior is changing radically as global citizens recognize the risks associated with coronavirus.

Markets discount the future and with the war against coronavirus intensifying with “all hands on deck” (and even possibly uniting Democrats and Republicans!) – testing (and an expansion of sites), the development of vaccinations and economic support to those adversely impacted – the market can now begin to look to the other side. (Importantly, two quarters of even very weak EPS are relatively meaningless in the scope of valuation models – representing about 5% of the value of a common stock based on a dividend/cash flow model.)

As to corporate profits, [it’s] hard to make a 2020 S&P EPS forecast. But, given the circumstances, that projection may lose its relevance – as what is more important is whether the earnings power of the S&P has been materially adversely impacted.

Some earnings issues may linger, but I don’t think earnings power will be diminished as long as the liquidity is properly provided and the credit plumbing problems are remedied.

Oil Vey!

Some are suggesting that the precipitous drop in the price of energy products is another Black Swan – but I disagree. The oil price decline is a “zero sum game.” While large oil companies suffer, the consumer and oil consuming countries benefit.

Looking to the “Other Side”

With massive stimulus announced, still lower interest rates (for longer) and tepid inflation, that other side, sometime in this year’s second half — will probably result in a quick acceleration of real economic growth late in 2020 as latent demand and stimulation clicks in.

Importantly, this will extend the business (profit) and economic cycle at a time in which the risk premia, the difference between the risk free rate of return and the earnings yield (inverse of P/E ratio), are settled at the most attractive levels in years.

Do Not Lose Sight of How Far Stocks Have Fallen

With stock prices back well below intrinsic value – for the first time since late 2018 – and with a record and abrupt move in investor sentiment from complacency to fear, a market “snapper” is not out of the question.

Back to Howard Marks: “Overall I think the news about the disease seems certain to get worse. The key questions are how the news will compare against the expectations factored into security prices and whether and when we will get the virus under control.”

Optimism and complacency [are] gone and pessimism is everywhere – a necessary reagent of a market bottom or bottoming process.

In all likelihood, the markets will rally before COVID-19 shows signs of being arrested.

Here is some good data and observations from Scarsdale Securities which shows the conflict between a vertical drop in stock prices and a massive erosion in investor sentiment:

On the charts, all the major equity indexes closed notably lower yesterday with broadly negative internals on heavy trading volume.

* As well, all broke below their respective support levels that have proved to be of little value during this selloff.

* They are in nearly vertical downtrends while we have yet to see any improvement in the equally negative advance/decline lines.

* The SPX is just shy of hitting its 12/18 low while the DJT broke below its long-term uptrend line that had been in place since 2009.

* At this point, there is nothing on the charts suggesting a positive reversal is imminent.

The data, on the other hand, is sending quite a different message from a sentiment perspective.

* All the McClellan 1-day McClellan OB/OS Oscillators remain deeply oversold but have been so throughout the recent rout (All Exchange:-159.09 NYSE:-162.96 NASDAQ:-154.48).

* However, the Open Insider Buy/Sell Ratio has spiked to 401.3 which is the highest level of insider buying since 9/11. Prior to the correction it was a bearish 21.9.

* On the opposite side of the scale, the detrended Rydex Ratio was -3.51 yesterday morning, more short than 9/11 and only surpassed twice in the past 10 years. It is currently a bullish -1.8 and in sharp contrast to its bearish signal prior to the correction at a +1.12.

* This sentiment setup was seen 4 times over the past decade. Each was concurrent with a significant market bottom.

* The counterintuitive % of SPX issues trading above their 50 DMAs is near a record low of 1.2%.

* The SPX at a 13.9 forward multiple via yesterday’s consensus forward 12-month earnings estimates from Bloomberg of $172.1.86 with the “rule of 20” finding fair value at a 19.3 multiple still suggests the SPX remains significantly undervalued.

* The SPX forward earnings yield is 7.2% with the 10 ten-year Treasury at 0.73%.

My Base Case

Though many companies will be damaged over the short term, my assumption is that the disruption will last for about two months and then we will return to something “slightly less than normal” (negative wealth impact) and COVID-19 will not likely permanently deliver a body blow to global economic growth or earnings power.

Where To Invest? 

* Look to FANG, financials and selected industrials

Though this may not be “the” time to buy, it may be “a” time to buy.

As I noted yesterday in my Diary and on Twitter, in a panic “all correlations go to one” as the baby is thrown out with the bath water.

For many, (SPY) and (QQQ) is a simple, liquid and tax efficient way to buy stocks now – and I have done that on the recent weakness.

As to individual sectors, my view is that banking stocks may have made a “generational” low last Thursday afternoon:

  • Bank stocks are underleveraged and overcapitalized
  • Bank managements are superior to those in the past – they are prepared for less favorable times
  • Loan books are more diversified compared to any time in history
  • The moats of large money centers is deepening – deposits continue to grow as the large banks gain loan and deposit share
  • Though buybacks have been suspended for several months (it’s an “optics” and PR issue in the face of Fed’s decision to provide “free money” on Sunday), when they return, done at large discounts to book value, are enormously accretive to EPS. (I would note that Wells’ (WFC) CEO Scharf just announced that he personally purchased 176k shares at $28.69 of WFC for about $5 million).

Amazon (AMZN) (my largest long) and Alphabet (GOOGL) are my favorite individual names – as discussed yesterday their moats, too, are growing and they have outdistanced any possible rivals.

Note: Today’s opener is not meant to be a comprehensive analysis of a rapidly changing economic and investment setting which has been disrupted by COVID-19. It is intended to be a summary.

Positions: Long BAC, C, WFC, JPM, GS, AMZN, GOOGL, SPY, QQQ

8) It’s good to see that, even in this era of political polarization, both parties appear to understand the need for massive fiscal stimulus. It shows that they’ve learned one of the key lessons from  the global financial crisis, when the stimulus was far too small: Trump administration seeks roughly $850 billion in emergency stimulus to confront coronavirus economic fallout.

9) Every day, my analyst prepares two charts for me showing the number of new coronavirus cases by day for the U.S. and the rest of the world (excluding China). Here’s the first:

The U.S. is behind the rest of the developed world, which is great news. This gives us time to react via various measures like social distancing, which means we have a good chance to “flatten the curve.”

But it’s also important to understand that, because we’re earlier in the curve, there are surely far more people infected than the 4,744 we’ve identified so far. Thus, as we ramp up our testing, the number of new cases will almost certainly rise very rapidly for a period – a week or two if we’re lucky, a month or two if we’re not.

Here is the chart for the rest of the world:

It’s great to see the dip in the last day. As you can see in the chart, this has happened a few times before, but I’m cautiously optimistic that we’re at – or at least very close to – a top…

10) Other than the city of Wuhan, China, Italy has been hit harder than anywhere, which has overwhelmed hospitals, led to 2,158 deaths (second only to China), and brought the nation to a virtual standstill. Thus, it’s particularly heartening to see the decline in new cases – again, let’s hope this is the beginning of a downward trend…

Best regards,

Whitney

P.S. In case you missed yesterday’s e-mail, I created a new e-mail list for my friends and family where I’ll be following and commenting regularly on the coronavirus crisis. I’m pleased to see than more than 2,200 have already joined it. If you’d like to as well, simply send a blank e-mail to: [email protected].

Whitney Tilson

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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to nearly $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor's degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

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