Hello everyone. I'd like to share with you my recent thoughts about markets, probably most of it is the continuation of what I am writing weekly to my subscribers. If you'd want to see more you can subscribe and receive the mentioned reports every Monday. The date of issuing this take was 18.05.2020.

If you like my articles consider a monthly subscription of my Weekly Market Letter, providing investors, students, financial journalists, investment funds, and market watchers insightful analysis about macroeconomic data and a variety of investment asset classes. Subscription includes 40-50 pages of content MONTHLY. The cost of services is 11 USD per month.
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I send the reports either on Sundays or Mondays VIA EMAIL, at the latest before the US Stock Market open. Just drop me a message on Twitter or to my email amdalleq@gmail.com sending your email address after you paid.

Is the insolvency phase unfolding?
“The truth is that liquidity is the only significant weapon in the central bank's arsenal, but it will not necessarily go where you want it to go.” - Martin Mayer
Liquidity, money injections into the financial system, money creation, currency printing – we can call it whatever we want. The quote perfectly describes current problems in the economy. We’ve already mentioned in one of the letters that less than 50% of the money printing or even as less as 10% goes to the real economy. This is because the money (or reserves which supposed to be used for lending) created by the central banks reaches commercial banks with the hope that it will be passed to the public via credit. But if people don’t want to spend (borrow) due to a crisis, high indebtedness or their budgets are significantly harmed and they want to save then the currency is stacked in the financial system and the so-called velocity of money (how fast a dollar changes hands) is falling while the money supply is exploding and nothing happens to economic growth (GDP). The graph below shows that the money supply has increased by 21.6% (red line) in April 2020 in comparison to April 2019.

The velocity of money (blue line) has dropped to its all-time low. In simplistic terms, it means that the economic recovery will be likely much more painful than in the previous economic cycles and central banks will try to inject even more currency into the system. These enormous money injections have facilitated a big bounce in risky assets such as stocks and corporate bonds in the United States for the time being because that money (or a significant bulk of it) eventually has to go somewhere. The real problem occurs, however, when individuals and companies have cash flow issues and they become bigger than the speed and accuracy of central banks’ printing as well as government spending. It may happen but as always nobody can be sure when. Therefore, I would like to outline some serious risks around that topic which we have to be aware of and they might affect our future investment decisions.

So far, governments around the world have announced more than $8 trillion of different aid packages while the central banks have pledged to buy $7.9 trillion assets this year (they’ve already bought roughly 5$ trillion with more than 50% purchases conducted by the Fed). When we compare it to Global GDP which reached $87.3 trillion in 2019 these numbers aiming to rescue the economy are huge. Furthermore, authorities and analysts are saying that it is not gonna be enough. As we’ve learned in previous letters government deficits, debt levels and the total value of assets on central banks' balance sheets have been exploding. We don’t know what will be the real consequences of that in the future but let’s put it aside for now. 

It has to be emphasized that these gargantuan numbers are not aimed to boost the economic recovery but rather to help go through the crisis as most countries have been going through lockdowns. This is the case especially in terms of government fiscal programs. Nothing surprising then that we are witnessing spectacular economic destruction, especially in the United States and the Eurozone. The recent example is US retail sales which have dropped -16.4% in April (the most on record) much more than -12.3% expected, and -8.3% fall in March.
source: Thomson Reuters
According to Trading Economics, the “Biggest declines were seen in sales of clothing and accessories (-78.8 percent), electronics and appliances (-60.6 percent) and furniture (-58.7 percent).” On the upside, nonstore sales have experienced an 8.4% increase – think about companies like Amazon and eBay. That’s a very substantial hit for many companies from this sector. A great example is a bankruptcy of J. Crew (retailer) we talked about last week. 

This also significantly harms unemployment as there’s no need to keep labor when almost nobody is buying things. The chart below shows how many jobs have been lost across different industries in April (blue) compared to the 12-month average (red).
As I mentioned last week, many of these job losses will be permanent, and potential economic and cash flow recovery will depend on how long the unemployment will last, among many other factors. Let’s bring an extreme example showing why it is going to be a difficult road ahead – airlines. On Sunday, the world’s biggest long-haul carrier – Emirates said that it is considering a reduction of 30,000 jobs and cut payrolls by as much as 30% to reduce costs. On Friday, United Airlines has told its employees that it only needs 3,000 of 25,000 flight attendants in June and warned that it can conduct massive layoffs after September (the US government CARES act aid which helps to pay flight attendants expires on Sept. 30). Furthermore, according to Reuters, Delta Air Lines told its 14,500 pilots on Thursday that it expects to have 7,000 more than it needs in the fall.

A less extreme example would be restaurants and cafes. After reopening they have to maintain social distancing measures, therefore, let’s say only 20-30% of the usual capacity will be served due to those restrictions. Having said that we know that they won’t need the same number of staff as before the crisis. Furthermore, OpenTable has surveyed thousands of them and said that 25% will never reopen. Unfortunately, the reality is heartbreaking, and it will last for some time.

The aforementioned activities and data are reflected in the GDP forecasts. St. Louis Fed’s Economic News Index (ENI) uses economic content from key monthly economic data releases to forecast real GDP growth during the current quarter. The index is subject to changes after subsequent data releases. 

On Friday it showed a 48.07% annualized DROP in the US GDP in the second quarter of 2020. Annualization here means that if the current economic conditions will last for 12 months then the real GDP will be almost halved – from the current $21.2 trillion to roughly $11 trillion. But this data is for one quarter, so the real drop would be approximately 10-11%, or $2.1 trillion. Nevertheless, such an economic hit has never been seen before. This crisis is so abrupt and unexpected that forecast from the last weeks of March by the biggest financial institutions are far away from mentioned 48.07%. Ironically James Bullard, 12th President of the Federal Reserve of St. Louis said on March 22 that the lockdown in the United States might even bring a 50% drop in the Q2 2020 GDP (annualized) – and it appears to be closest to the truth.
However, we still have to wait 1.5 months to conclude the quarter.

Alright, we know that the economic hit is severe, the unemployment rate has risen to 14.7% and will likely go above 20%. Also, more than 80 big companies have filed for bankruptcy in 2020. Apart from J.Crew, it was John Varvatos (clothing), Neiman Marcus (retailer), Gold’s Gym (fitness), True Religion (Jeans retailer), Dean & Deluca (grocery stores), Stage Stores (retail), JC Penney (retail) and many others. Unfortunately, if consumers will continue their hesitation in terms of spending and unemployment will be not recovering as fast as many expect we may see a record number of bankruptcies. Number not even seen in 2008-2009.
This chart suggests that the number of total bankruptcies (all corporations, partnerships, and limited liability companies) may reach twice the number than in 2009. Thus, as the graph says, the narrative is changing from liquidity to solvency. It is worth reminding us that liquidity is an ability to meet short-term obligations and solvency is an ability to meet long-germ debts and financial obligations. A question that arises is has the market fully discounted the potential wave?

Going further, the US Chamber of Commerce said that more than 40% of 30 million small businesses could close permanently in the next six months due to pandemic. The chart shows that nearly 50% of those businesses will be out of cash in just a month (and the survey ended on May 2)!
Remember that small businesses have been employing 47% of the workforce. That would mean 18.8% unemployment only in that area so we also have to add to this the remaining 53% of the workforce.

All things considered, it is easier to understand why analysts said that several trillions of dollars of stimulus are not enough to go through the crisis. Thus, it creates a huge cash flow problem both among companies and among people going forward. According to the Labor Department, more than 36 million American workers have applied for jobless insurance (initial jobless claims) – basically 25% of the labor force. And only 60% of them received those benefits from states. According to the Federal Reserve data, 48% of laid-off people or facing reduced working hours in April said that they were “finding it difficult to get by” or “just getting by”. It is not a coincidence then that almost 50% of people have withdrawn money or planning to withdraw from their retirement accounts according to an online survey of 1239 Americans with a retirement savings account.
Probably most of them have done that when the market has been trading around its lows. I think this is just the beginning and the Federal Reserve is well aware of these issues and gives us some signals.

On Friday, they released the Financial Stability Report (assessment of the US financial system issued twice a year). In the report, they warned that stocks and other asset prices such as real estate could suffer significant declines if the coronavirus pandemic will last for longer:

“Asset prices remain vulnerable to significant price declines should the pandemic take an unexpected course, the economic fallout proves more adverse, or financial system strains reemerge,”

Emphasizing that the most exposed are commercial real estate:

“prices were high relative to fundamentals before the pandemic,”

Well, I think that does not need any commenting. The remaining risks are very significant.

Speaking about the Fed and its dilemmas ahead there is also an interesting theory to bring in.

As we know, the US Government is going to issue $3 trillion of debt during this quarter. Some forecasts show that there can be more than $5 trillion of Treasury bond issuances in 2020. Recall that when there is a huge supply of bonds in a short period without a major buyer it may cause the cost of that debt (interest) to increase to attract buyers. So far, however, the major buyer has been the Federal Reserve through the secondary market (direct purchases from the US Treasury are prohibited). The first chart shows that Fed Treasury purchases have been exceeding the net issuance of the US government debt.
The second chart presents monthly changes for both activities which have been conducted at the same pace.
That was the case when the US Central bank has been buying a record of $75 billion Treasuries a day. In effect, the number of Treasuries held by the Fed has increased by $1.5 trillion in just two months.
But now, the number of purchases has been trimmed to $30 billion PER WEEK which makes things much more complicated. There might be not enough buyers for the US Government Bonds. Thus, how would the Fed explain another ramp-up in US debt purchases considering that the market has stabilized? Well, you have to let it fall again. What would be worse – a massive explosion in US government yields meaning much higher interest expenditure for the government and very significant tax increases or declines in the US stocks and corporate bond market to justify another intervention - next round of massive Treasury purchases? It seems like the Fed has no other choice than doing this. Especially, seeing that foreigners are selling US bonds because of US dollars shortages around the globe.
Foreign investors sold $256.7 billion of US treasuries in March, the most ever. We still need to wait for April data for the confirmation because in the meantime the Fed introduced a variety of programs for foreigners to access US dollars.

This theory is quite controversial and it would be interesting to see if that materializes. The balance sheet of the most powerful central bank in the world has already reached $6.93 trillion.
With the upcoming substantial US Treasury Bonds issuances, we may see $8 trillion by the end of this quarter easily.

We will watch those developments carefully. Let’s now revisit some charts from the previous weeks.

The S&P 500 couldn't find any clear direction for the last couple of weeks.
It is moving between 50% (green horizontal line) and 61.8% (light blue line) retracement from March 23 lows. The subsequent moves in the next days will be probably triggered by the Fed actions as well as Trade War developments between the United States and China.

As far as you are concerned, I am not a fan of the S&P 500 index and to me, it is better to look at Russell 2000 or small-capitalization stocks to see a less manipulated picture.

It broke its ascending channel (white lines) and bounce off its 50-day moving average. From this perspective, I would expect a retest of the channel and downside continuation unless something big happens in terms of monetary (central banks) or fiscal (governments) policy. Keep in mind these historic valuations I brought in the last report.

Remember Spain (stock index IBEX) and its massive head and shoulder pattern?
The index fell 4.5% last week… It will be difficult to break the line but if it does then the next stop is 4000.

And news coming from the country is not encouraging:

121,827 small businesses went bankrupt in Spain in MARCH. Almost 10% of the total small businesses. What, therefore, happened in April when lockdown has been in full place? May may not be better either.

And, here we can see how the Spanish stock market is trading versus the S&P 500.
source: The Market Ear, Thomson Reuters
Which is getting me wondering, why everybody is excited by the US stocks. 

If you would like to pick winners of the crisis so far. These certainly are Internet stocks (blue line) gaining 11.58% this year while the S&P 500 is 11% down.

Ticker FDN is the First Trust Dow Jones Internet Index Fund having technology stocks such as Amazon and Facebook in its composition.
In the last report, I highlighted the 10 year US Treasury yield and its divergence with the S&P 500. This time I’d like to show how it trades against the KBW Bank Index consisting of 24 US banking stocks.
Banks do not have to take a lead in terms of the entire stock market but they have to be resilient if we are thinking about the real economic recovery. Keep that in mind.

Speaking about the recovery. It is worth looking at this chart. The yellow line shows the gold price which is gaining 15.65% this year while the gray line is the Exchanged Traded Fund (ETF) GDX. This fund is a composition of large-capitalization, global gold miners. Currently, it is benefiting from the higher gold prices, among others, rising 24% this year.
It has to be emphasized that GDX volatility and risk are much bigger than holding gold and these companies have also been significantly hit during the liquidation phase in March falling as much as 35%.

When we compare gold to silver. The latter is still lagging, although it has had a very great week.
Interestingly, Bitcoin has also experienced a very decent recovery, up 28.35% of the year.
More people are starting to treat cryptocurrencies seriously. To me, it is a big unknown how it could behave during a crisis like the current one. Having said that I think it is an asset that has a 50% probability to go to 100,000 USD and a 50% probability to go to zero.

In terms of the currencies, the US Dollar is continuing its rise against Brazillian Real (blue) and forming a flag against a Mexican Peso (gray) which I believe will break to the upside as Emerging Markets are still scrambling for dollars.
And EURUSD pair is getting closer to its more than 20 years trend (bottom red line).
If we break that level then as I said previously 0.90 is a great possibility which I highlighted using a yellow line.

I’d like to conclude with Neil Irwin, senior economics correspondent for The New York Times words:

“It would be foolish, amid such uncertainty, to make overly confident predictions about how the world economic order will look in five years or even five months.”

I agree with the quote and I would add that we have to follow some framework getting us through those uncertain times and we should be open to adjusting it if dynamic changes. That’s everything for today. If you have any questions just drop me an email I will expand my way of thinking if needed. I am always happy to see and respond to your messages.

Thank you for reading and I wish you a great weekend ahead.

Stay Safe. 


If you like my articles consider a monthly subscription of my Weekly Market Letter, providing investors, students, financial journalists, investment funds, and market watchers insightful analysis about macroeconomic data and a variety of investment asset classes. Subscription includes 40-50 pages of content MONTHLY. The cost of services is 11 USD per month.

You can find out more in the tab MY SERVICES
I send the reports either on Sundays or Mondays VIA EMAIL, at the latest before the US Stock Market open. Just drop me a message on Twitter or to my email amdalleq@gmail.com sending your email address after you paid.