Bull Market or Bull Trap?
"The course of the flight up and down was exceedingly erratic, partly due to the irregularity of the air, and partly to lack of experience in handling this machine.” -- Orville Wright March 29, 2020
Orville could just as easily have been discussing the markets as he was flight. We had another volatile week in the markets as investors continue to stumble about in irregular air, lacking any experience with such an unwieldy economic and financial machine. We started off Monday with the Fed once again desperately trying to restore calm in the financial markets. Its first 15 policy actions haven’t done the trick, each landing with a thud and necessitating increasingly desperate attempts. Number 16 was a doozy.
The Fed removed any prior dollar constraints on its purchases of Treasury and mortgage-backed securities and introduced a slew of additional acronyms to support a variety of other security types. The Fed has blasted so much buckshot in the past month that it’s nearly impossible to keep track of all their programs, let alone assess their likelihood of short-term and long-term success or their inevitable unintended consequences. They hoped they could loosen the valve on the hydrant just a bit last fall, but they’ve lefty-loosened things so many times now that they’ve lost control of their fire hose and are soaking indiscriminately.
In addition to the parade of Fed programs, the federal government just passed its own stimulus, a further $2 trillion of spending. Lost in the rushed panic to pass this bill has been any discussion of where the money is coming from to pay for it. Are taxes being raised? Is spending being cut elsewhere? Pshaw! Such silly questions in this brave new world of free money and no consequences. We were already running a $1 trillion annual deficit before the virus hit, when our Grand Poobah was declaring the economy the best, more amazingest, recordist economy in the history of the multiverse. Another $2 trillion? Just add it to our tab. What a fortunate coincidence that the Federal Reserve now stands ready to buy whatever amount of Treasury debt it deems necessary to keep the wheels of finance greased, with “money” conjured from the depths of its Dell Inspiron PC’s central processing unit. It’s the same playbook as the last crisis, only bigger and faster. Print, borrow, spend, self-congratulate, repeat.
Doomed to Fail
Whatever the short-term ramifications of these policies, they do absolutely nothing to address our already tremendous debt problem or the overvaluation of assets. Quite the opposite, debt will grow further, and the Fed will do its best to keep asset prices from falling to free market levels, levels at which level-headed folks like myself would be happy to buy.
The chart below tells an incredible story. It encapsulates much of what we’ve been talking about in recent years – stocks (red line) were in a bubble, and the Fed was trapped and could never meaningfully reduce its balance sheet (blue line). The Fed was able to reduce its balance sheet modestly over the course of 21 months beginning in early 2018. I’ll admit that they got a little further down that path than I thought they could, but this attempt to rein in its prior recklessness was completely undone in 5 short months beginning last September. You’ll find something even more amazing if you squint and look at the rightmost portion of the chart. Do you see that spike? In the span of only three weeks, the Fed has increased its balance sheet by an incredible $1 trillion. Three weeks. $1 trillion. They’re not done yet.
Printing money out of thin air and buying assets without regard to price or value is easy. There is no genius in that. Opposable thumbs aren’t even a requirement for the job. When the Fed first started QE, it assured the markets that it was temporary and that they would reduce the balance sheet once the markets and economy were “normal.” Investors gave the Fed the benefit of the doubt. This time around, it’s hard to imagine anyone believes this is temporary. There is no realistic positive end game for our unending debt and monetary stimulus. At some point, we’re likely looking at an entire reset of the monetary system. Whatever the ultimate timing, the ETA has been pushed forward. So, yes, I still like gold.
Bull Market or Trap?
As for the here and now, everyone is wondering if the market rally last week was the beginning of a bull market or just a bull trap (see chart). Is the coast clear or did we just witness a massive three-day head fake? The strongest rallies come during bear markets, so we can’t really read too much into last week. What I do know, however, is that the market has yet to drop to levels that I find tempting. Some time-tested valuation metrics show that stocks have only fallen back to the PEAK levels of the last bubble. Does that mean that the stock market must go a lot lower? No. It just means that we’re still not getting paid well enough to take on the risk of broad stock exposure. Whatever downside remains, I fully expect some big rallies ahead, especially once the coronavirus subsides and businesses reopen. The psychological catharsis alone should spur a big move, if only fleeting.
Fortunately for us, we remain rather agnostic on the market. We took advantage of the big drop on Monday to sell most of our remaining put options. We’re now left with just a few stragglers in some accounts that we held to keep our overall risk exposure on target. We continue to high-grade portfolios – selling some names with less upside to build the bargain positions that we expect to provide greater returns. Moving forward, the plan is to continue to take advantage of whatever this bout of volatility provides, in either direction. We have cash to deploy if things really get ugly (compelling), and we have positions that would benefit from market rebounds. We’re going to remain flexible, nimble, and disciplined.
I’m very comfortable with the “risk” portion of our portfolio. Gold and the mining equities have an incredible tailwind, with central banks around the world firing up their printing presses and slashing interest rates while governments jack up their spending and debt. I added a few new positions a couple weeks ago when gold was slapped down and the mining stocks were crushed due to some forced ETF-related selling. I cautioned that even gold would likely be hit during a panic. In the 2008 crisis, gold dropped 25% over 8 months before storming back to its highs three months later. It went on to add 160% in the next two years. Thus far in this bear market, gold fell 12% over the course of 1 ½ weeks before rallying back one week later. This crisis will remind investors of the important role gold plays as a store of value with no counterparty risk.
Our oil shippers have been solid of late. The oil price war between Saudi Arabia and Russia is a boon to these companies. The price of oil has collapsed from $60 at the beginning of the year to $21 today, but the futures curve is in very steep contango. This means that oil can be bought for $21 right now, and the buyer can simultaneously sell a November futures contract at $34, locking in a $13 profit per barrel for storing oil 6 months. That’s a huge incentive to store oil, and our oil shipping companies are benefitting. Charter rates have exploded as demand for floating storage is increasing. In addition, anyone with extra land storage is looking to stock up at these low prices, adding to shipping demand. Insiders have been buying stock, and these companies are going to be reporting some mind-boggling results for as long as this situation holds. These companies will be paying down debt, buying back stock, and/or issuing big dividends.
The long-term uranium outlook keeps getting better, despite the languishing equities. We were already running a large annual supply deficit, and now we have mines shutting down due to the coronavirus, hastening the depletion of existing inventories. As I’ve highlighted in the past, this entire industry is currently worth a paltry $7 billion. When the next uranium bull market kicks off, we’re going to see fireworks. In the meantime, the price of uranium itself has held up well during this downturn and actually increased nicely last week on the back of some mine shutdown news. We keep nibbling.
Aside from these core positions, we added a few of the largest oil companies a couple of weeks ago as the price of oil was plummeting and the stocks were getting destroyed. We bought strong companies with decent balance sheets and dividend yields in the 12-17% range. We also added an oil shipping preferred stock that was sporting a yield of 26% at the time. The panic is creating some fantastic opportunities, despite the market still being expensive. Bull market or bull trap? It really doesn’t matter to us. We’ll just continue to manage portfolio risk and take advantage of the volatility ahead.
Ken Bell, CFA, CFP, MBA, Fire Hose Inspector
Aspera Financial, LLC
The Market Rubbernecker is associated with Aspera Financial, LLC, an investment management and financial planning firm based in the Cary, Raleigh, and Durham area of North Carolina. This and all Market Rubbernecker missives and musings (written, oral, or mimed) are subject to the disclaimers, disavowals, and hindquarter-coverings found at www.asperafinancial.com/aboutrubbernecker.